If I Go Bankrupt, What Happens to My House?

When facing significant financial challenges, individuals may consider bankruptcy as a path to a fresh start. This process, while offering relief, introduces complexities, especially concerning a homeowner’s primary residence. Understanding how a home is treated within a bankruptcy filing is crucial. This article explains how bankruptcy impacts home ownership and asset protection.

Understanding Bankruptcy Types and Their Impact on Your House

Bankruptcy law provides pathways for individuals to address financial difficulties, with Chapter 7 and Chapter 13 being the most common for consumers. Each chapter approaches the treatment of secured assets, such as a home, influencing whether a homeowner can retain their property. Chapter 7 liquidates non-exempt assets to repay creditors, while Chapter 13 focuses on a structured repayment plan.

Chapter 7 bankruptcy involves the sale of a debtor’s non-exempt assets by a trustee to pay debts. If a homeowner has significant equity in their home not protected by an exemption, the trustee may sell the property to distribute proceeds to creditors. However, many homes are protected by exemptions, allowing debtors to keep assets. The debtor receives a discharge of most unsecured debts.

In contrast, Chapter 13 bankruptcy is a reorganization, allowing individuals with regular income to create a repayment plan for their debts over three to five years. This chapter is preferred by homeowners who wish to keep their homes, especially if behind on mortgage payments. The repayment plan can include missed mortgage payments and payments to other creditors. Adhering to the confirmed plan allows debtors to retain their home.

Protecting Your Home with Exemptions

Bankruptcy exemptions are provisions protecting assets from sale by a bankruptcy trustee. These exemptions determine whether a homeowner can keep their primary residence during bankruptcy. The most relevant exemption is the homestead exemption, which shields a portion or full equity in a primary residence.

The availability and value of homestead exemptions vary based on federal or state exemption laws. Federal law provides exemptions, but most states have their own, requiring debtors to choose between federal or state options. Some “opt-out” states require debtors to use state exemptions, not federal. Equity protection varies widely by jurisdiction, from thousands to unlimited amounts.

To illustrate how a homestead exemption works, consider a home with a market value of $300,000 and an outstanding mortgage balance of $200,000, resulting in $100,000 of equity. If the applicable homestead exemption in that jurisdiction is $150,000, the entire $100,000 of equity would be protected, meaning the home generally would not be sold by a Chapter 7 trustee. However, if the home had $200,000 in equity and the exemption was still $150,000, the remaining $50,000 in equity would be considered non-exempt. In such a scenario, a Chapter 7 trustee might sell the home to access that non-exempt equity for distribution to creditors, though debtors often have options to pay the non-exempt amount to the trustee to keep their home.

Exemptions establish which assets are protected before the bankruptcy process unfolds. Debtors must accurately list all assets and claim the appropriate exemptions in their bankruptcy petition. Properly claiming exemptions preserves assets; any misstep could lead to property loss. Understanding specific homestead exemption limits and rules is crucial for navigating bankruptcy with a home.

Managing Mortgages and Home Equity

The treatment of existing mortgages and home equity are key considerations in bankruptcy. Handling these details depends on the bankruptcy type and debtor’s property objectives. A mortgage means the home serves as collateral for secured debt, treated differently than unsecured debts like credit cards.

In a Chapter 7 bankruptcy, a homeowner has two options for their mortgage: reaffirmation or surrender. Reaffirming a mortgage involves a new agreement with the lender to continue payments, even after personal liability is discharged. This allows the homeowner to keep the property by remaining current on payments. Alternatively, a debtor can surrender the home, giving it to the lender, and the personal mortgage obligation is discharged.

For homeowners in Chapter 13 bankruptcy, the approach to mortgages differs, especially if behind on payments. A Chapter 13 plan allows debtors to cure mortgage arrears by including missed payments in the repayment plan over three to five years. By making regular monthly mortgage payments and arrearage payments through the plan, debtors can avoid foreclosure and retain their home. This structured repayment helps catch up on past-due amounts without immediate lender action.

Home equity, the market value minus outstanding secured debt, directly impacts how the property is treated in bankruptcy. If the home’s equity exceeds the applicable homestead exemption in Chapter 7, the non-exempt portion becomes an asset available to the bankruptcy trustee. For example, if a home is valued at $400,000 with a $250,000 mortgage, with $150,000 in equity, and the homestead exemption is $100,000, then $50,000 is non-exempt. This non-exempt equity may lead to the trustee selling the home unless the debtor buys out the non-exempt portion.

In some Chapter 13 cases, lien stripping may be available for junior mortgages or HELOCs. If the home’s value is less than the first mortgage balance, making the junior lien unsecured, the Chapter 13 plan may treat the junior lien as unsecured debt. It would be paid at the same percentage as other unsecured creditors, and upon plan completion, the lien would be removed. This option can reduce the total home debt burden.

The Post-Filing Home Status

After a bankruptcy case is filed, the homeowner’s residence enters a procedural phase where decisions and details manifest. The bankruptcy trustee assesses the debtor’s assets, including the home, particularly in Chapter 7 cases. The trustee identifies and liquidates non-exempt assets to distribute proceeds to creditors.

In a Chapter 7 filing, if the home’s equity is fully protected by the applicable homestead exemption, the bankruptcy trustee will “abandon” the property. This means the trustee determines there is no non-exempt equity for creditors, relinquishing any claim to the property. The debtor then retains ownership of the home, remaining responsible for mortgage payments if they reaffirm the debt. If there is non-exempt equity, the trustee may sell the home, or the debtor can pay the trustee the non-exempt equity to keep the property.

For Chapter 13 bankruptcy, the home’s status depends on the repayment plan’s confirmation and completion. Once the bankruptcy court confirms the Chapter 13 plan, the debtor is obligated to make regular payments as outlined in the plan, including missed mortgage payments or other secured debt payments. Adhering to the plan’s terms and making all required payments allows debtors to retain their home. The plan provides a pathway to financial reorganization while preserving the asset.

While a bankruptcy discharge eliminates personal liability for mortgage debt, the mortgage lien typically remains attached to the property. Even after a discharge, homeowners wishing to keep the property must continue mortgage payments. If payments cease, the lender can foreclose, regardless of the bankruptcy discharge. The discharge addresses the debtor’s personal obligation, not the property’s encumbrance.