How Much Equity Can You Have in Your House and File Chapter 7?

Chapter 7 bankruptcy offers individuals a path to financial relief by discharging most unsecured debts, such as credit card balances and medical bills. This “liquidation bankruptcy” involves the potential sale of assets to repay creditors. A central consideration in Chapter 7 is how home equity impacts the process, as it represents a significant portion of a homeowner’s wealth. Understanding how this equity is assessed and protected is important for those considering bankruptcy.

Understanding Home Equity and Exemptions

Home equity is the portion of a property’s value a homeowner owns, free from outstanding loans or liens. To calculate, subtract total owed on mortgages and other secured debts from the home’s current market value. For example, a home valued at $400,000 with a $300,000 mortgage carries $100,000 in equity. Equity is an asset in bankruptcy proceedings.

Protecting equity in Chapter 7 relies on homestead exemptions, legal provisions allowing debtors to safeguard a certain value in their primary residence from liquidation. These exemptions vary significantly, with debtors choosing between federal or state-specific exemption systems. The federal homestead exemption, for instance, protects up to $31,575 of equity in a principal residence for cases filed on or after April 1, 2025. Married couples filing jointly can double this amount, protecting up to $63,150 if both spouses have an ownership interest in the property.

Many states have “opted out” of the federal system, requiring debtors to use state-specific exemptions. Other states allow debtors to choose between federal or state exemptions, but not combine elements. State homestead exemption amounts vary widely, some offering more generous protections than federal amounts, others with more limited coverage. For instance, some states might protect equity up to several hundred thousand dollars.

Exemption system choice depends on residency rules. To use a state’s homestead exemption, a debtor must reside in that state for a minimum of 730 days (approximately two years). If this residency is not met, debtors may use exemptions from the state where they lived for most of the 180 days preceding the two-year period before filing. Federal law caps the homestead exemption if the debtor has not lived in the home for at least 40 months before filing. This rule prevents debtors from quickly moving to a state with a high exemption just before filing.

Protecting Your Home in Chapter 7

Homestead exemptions in Chapter 7 dictate whether a home is protected from liquidation. When a bankruptcy petition is filed, a bankruptcy estate is created, and a trustee is appointed. The trustee identifies and sells non-exempt assets to distribute proceeds to creditors. The trustee evaluates the debtor’s home equity against the applicable homestead exemption.

If homeowner equity is fully covered by the homestead exemption, the home is “exempt” property. The bankruptcy trustee cannot force the home’s sale to pay creditors. Debtors can retain their primary residence, provided they are current on mortgage payments. If mortgage payments are not current, the lender may still pursue foreclosure, independent of the bankruptcy process.

If home equity exceeds the available homestead exemption, the situation becomes more complex. This excess, “non-exempt” equity, is at risk of liquidation. The bankruptcy trustee may sell the property to recover the non-exempt portion for creditors. Should a sale occur, the debtor receives their exempt portion from proceeds. After mortgage holders and secured creditors are paid, the trustee distributes remaining funds, after deducting sales costs and trustee fees, to unsecured creditors.

The trustee pursues a sale only if it generates sufficient funds to cover the exempt amount, pay off liens, cover sale costs (including real estate commissions), and yield money for unsecured creditors. If selling costs, secured debts, and the exempt amount exceed the home’s market value, the trustee will not proceed with a sale, as it would not benefit creditors. If the home’s equity increases while the Chapter 7 case remains open, even if the equity was initially fully exempt, the appreciation could become non-exempt and lead to a sale.

Considering Alternatives

When a homeowner has significant non-exempt equity they wish to protect, Chapter 7 may not be suitable. Exploring alternatives can provide a means to retain the home. A primary alternative is Chapter 13 bankruptcy, a reorganization bankruptcy for individuals with regular income.

Under Chapter 13, debtors keep all assets, including a home with non-exempt equity, by proposing a repayment plan to creditors. This plan spans three to five years, with regular payments to the bankruptcy trustee. The repayment plan must ensure unsecured creditors receive at least as much as they would in a Chapter 7 liquidation. Plan payments must cover the value of any non-exempt equity in the home.

If non-exempt equity is substantial, monthly payments under a Chapter 13 plan can be very high, potentially making the plan unaffordable. The trustee will not sell the property in Chapter 13, but the debtor must pay an amount equivalent to the non-exempt portion creditors would have received in a Chapter 7 case. This approach allows debtors to preserve their home, but requires adherence to a strict payment schedule.

Beyond bankruptcy, other strategies may be considered, though they do not offer the same legal protections. One option is negotiating directly with lenders or creditors outside bankruptcy to restructure debts or establish payment plans. Debt consolidation (combining multiple debts into a single loan) or a debt management plan administered by a credit counseling agency might also provide relief by lowering interest rates or monthly payments. Another possibility is voluntarily selling the home before filing for bankruptcy, allowing the homeowner to control the sale process and potentially preserve equity, albeit outside bankruptcy protection.