If I File Bankruptcy, Will I Lose My House?

Many individuals facing financial hardship worry about losing their homes if they file for bankruptcy. The outcome for homeownership in bankruptcy is not uniform; it depends on various factors, including the specific type of bankruptcy filed and individual financial circumstances. Understanding how bankruptcy laws interact with property ownership is important for anyone considering this path.

How Bankruptcy Affects Homeownership

When a bankruptcy petition is filed, a “bankruptcy estate” is created. This estate legally encompasses all of the debtor’s interests in property at the time of filing, including their home. The purpose of this estate is to gather assets that can be used to repay creditors. While the home becomes part of this estate, it does not automatically mean it will be sold.

Debts are generally categorized as either secured or unsecured. A mortgage is a secured debt, meaning it is backed by collateral, which is the home itself. If the mortgage is not paid, the lender has the right to foreclose on the property. Unsecured debts, such as credit card balances or medical bills, are not tied to any specific asset.

A concept in bankruptcy is that of “exemptions.” These are legal provisions that allow debtors to protect certain property from creditors. The “homestead exemption” specifically protects equity in a primary residence. Equity is the difference between the home’s market value and the outstanding mortgage balance.

Chapter 7 Bankruptcy and Your Home

Chapter 7 bankruptcy, often referred to as liquidation bankruptcy, involves the sale of a debtor’s non-exempt assets by a court-appointed bankruptcy trustee. The trustee’s primary role is to maximize the return for unsecured creditors from non-exempt property.

If a home’s equity exceeds the available homestead exemption, the trustee may sell the home to pay creditors. However, many individuals in Chapter 7 do not lose their homes, often because their equity is fully protected by the homestead exemption or is minimal.

Debtors have options for dealing with their mortgage in Chapter 7. They can continue making mortgage payments to keep the home, provided their equity is protected. Alternatively, they can surrender the home, allowing the lender to proceed with foreclosure, and the personal liability for the mortgage debt will be discharged.

Chapter 13 Bankruptcy and Your Home

Chapter 13 bankruptcy is a reorganization bankruptcy that allows individuals with regular income to propose a repayment plan to creditors over three to five years. For homeowners, Chapter 13 allows prevention of foreclosure by catching up on missed mortgage payments, known as curing arrears, through the repayment plan.

Under a Chapter 13 plan, debtors must make ongoing regular mortgage payments in addition to payments towards the arrears. The plan spreads the missed payments over its duration, 36 to 60 months, making them more manageable. This allows debtors to avoid foreclosure and retain their homes if they can maintain the required payments.

Another feature in Chapter 13 is “lien stripping,” which can apply to junior mortgages or home equity lines of credit. If the value of the home is less than the balance owed on the first mortgage, any junior liens are considered “wholly unsecured” and can be reclassified as unsecured debt. These stripped liens are then treated similarly to other unsecured debts in the repayment plan, receiving only a small percentage of what is owed, and are discharged upon successful completion of the plan.

Key Tools for Home Protection in Bankruptcy

The homestead exemption is a primary tool for protecting a home in bankruptcy by shielding a certain amount of equity in a primary residence from creditors. The specific amount of the homestead exemption varies; debtors generally use either federal or state exemption amounts. Some states allow choice between federal and state exemptions, while others require state-specific exemptions.

To determine the applicable exemption, debtors identify the current market value of their home and subtract any outstanding mortgage balances to calculate their equity. This equity is then compared to the available homestead exemption amount. If the equity is fully covered by the exemption, the home is protected from liquidation in Chapter 7.

For secured debts like mortgages, debtors in Chapter 7 bankruptcy might consider a “reaffirmation agreement.” This is a legal contract where the debtor agrees to remain personally liable for a debt that would otherwise be discharged in bankruptcy. Reaffirming a mortgage means the debtor commits to continuing payments as if bankruptcy had not occurred, allowing them to keep the home and continue building equity.

While reaffirmation allows debtors to retain the property and rebuild credit through on-time payments, it also carries risks. If the debtor defaults on a reaffirmed mortgage, they remain personally responsible for the debt, and the lender can pursue collection actions, including foreclosure and a deficiency judgment. Without reaffirming, the personal liability for the mortgage is discharged, and while the home can still be foreclosed upon if payments are missed, the debtor is not personally responsible for any remaining balance after the sale.