Do You Lose Your House in a Bankruptcy?

Many individuals consider bankruptcy for debt relief. A significant concern for homeowners is the fate of their residence. The outcome depends on the type of bankruptcy filed, the amount of equity in the home, and the laws governing exemptions. Understanding these elements clarifies how to protect one’s home during bankruptcy.

Key Factors Affecting Your Home in Bankruptcy

Home equity is a primary determinant of a home’s treatment during bankruptcy. It represents the difference between the property’s current market value and the total amount owed on all mortgages and liens. For example, a home valued at $300,000 with a $200,000 mortgage has $100,000 in equity. This equity can be considered an asset available to creditors.

Bankruptcy exemptions play an important role in protecting a homeowner’s equity from creditors. These exemptions allow debtors to safeguard property from liquidation, and a homestead exemption applies to a primary residence. The amount of equity protected through a homestead exemption varies significantly across jurisdictions. Debtors choose between federal or state exemptions, depending on which offers more favorable protection.

The distinction between secured and unsecured debt is important when considering a home in bankruptcy. A mortgage is a secured debt, tied to the property as collateral. If the borrower fails to make payments, the lender can foreclose. Unsecured debts, such as credit card balances or medical bills, are not backed by any asset.

Maintaining current mortgage payments is necessary for homeowners who wish to retain their property. Even if other debts are discharged, the obligation to pay the mortgage persists if the homeowner intends to keep the home. Failure to make these payments can lead to foreclosure, regardless of the bankruptcy filing.

How Chapter 7 Bankruptcy Affects Your Home

Chapter 7 bankruptcy, or liquidation bankruptcy, involves a court-appointed trustee who oversees the debtor’s non-exempt assets. The trustee sells these assets and distributes the proceeds to creditors. If a homeowner’s equity exceeds the available homestead exemption, the home may be considered a non-exempt asset. In such cases, the trustee could sell the home to pay off creditors, with the homeowner receiving the exempt portion of the equity.

If the home’s equity is fully protected by the homestead exemption, or if there is no equity, the Chapter 7 trustee does not have a basis to sell the home. Homeowners have several options regarding their secured property. One common option is a reaffirmation agreement, where the debtor agrees to continue making mortgage payments and remains personally liable for the debt. This allows the homeowner to keep the property and rebuild credit.

Another option is redemption, which allows the debtor to pay the lender the current market value of the property in a single lump sum, owning it free and clear. This option is usually impractical for homes due to significant funds required. Alternatively, a homeowner can surrender the home to the lender. In a surrender, personal liability for the mortgage debt is discharged, and the lender can proceed with foreclosure.

In some Chapter 7 cases, junior liens like second mortgages or home equity lines of credit (HELOCs) may be “stripped off” if a property’s value is less than the first mortgage balance. This process, known as lien stripping, renders these junior liens unsecured and potentially dischargeable. This requires strict conditions, such as the senior mortgage exceeding the home’s fair market value.

How Chapter 13 Bankruptcy Affects Your Home

Chapter 13 bankruptcy, or reorganization bankruptcy, allows individuals with regular income to repay debts through a court-approved plan. This plan spans three to five years, with regular payments to a bankruptcy trustee. An advantage of Chapter 13 for homeowners is its ability to cure mortgage arrears. Past-due mortgage payments can be included in the repayment plan, allowing the homeowner to catch up while continuing regular mortgage payments.

Homeowners can retain their property in Chapter 13 regardless of equity, provided they adhere to their repayment plan and continue regular mortgage payments. The plan must ensure unsecured creditors receive at least as much as they would in a Chapter 7 liquidation. If there is non-exempt equity, the plan must account for that value by distributing an equivalent amount to unsecured creditors. This allows homeowners to keep their property even with substantial equity that might be at risk in a Chapter 7.

Lien stripping is a feature of Chapter 13 bankruptcy, often more accessible than in Chapter 7. If the home’s value is less than the first mortgage balance, any wholly unsecured junior liens (e.g., second mortgages or HELOCs) can be “stripped off.” These stripped liens are treated as unsecured debt within the Chapter 13 plan and are often discharged upon completion. This can reduce a homeowner’s overall debt burden and make their home more affordable.

Chapter 13 also includes “cramdown” for certain secured debts, primarily investment properties or vehicles. Cramdown allows the debtor to reduce a secured loan’s principal balance to the collateral’s market value, treating the remaining balance as unsecured debt. This provision does not apply to mortgages on a primary residence, but highlights Chapter 13’s flexibility in restructuring secured debt.

What Happens When a Home is Not Retained

If a homeowner chooses not to retain their property, or if circumstances necessitate its sale, the property enters the foreclosure process. If a home is surrendered in Chapter 7, personal liability for the mortgage debt is discharged. The mortgage lender then proceeds with foreclosure to recover the property and satisfy the outstanding loan. This allows the homeowner to walk away from the debt without personal financial repercussions.

Bankruptcy filings trigger an automatic stay, which temporarily halts most collection actions, including foreclosure proceedings. While this stay provides a temporary reprieve, it does not permanently prevent foreclosure if the home is unprotected by an exemption or repayment plan, or if mortgage payments cease. Once the bankruptcy case concludes or the stay is lifted, the lender can resume foreclosure if the homeowner is in default.

A benefit of bankruptcy, particularly Chapter 7, is the discharge of potential deficiency judgments. If a home is foreclosed and sold for less than the outstanding mortgage balance, the lender might pursue a deficiency judgment. However, if the mortgage debt was discharged, personal liability for any deficiency is eliminated. In Chapter 13, successful completion of the repayment plan also discharges any remaining personal liability for deficiency judgments.