If you have too much home equity, putting your home is at risk, Chapter 7 might still be a viable option, the best option.
In our July 1 blog post we gave a list of 10 ways that a Chapter 13 “adjustment of debts” case can help you keep your home. Next time we’ll finish this off with the last of those 10 ways. But today we take a detour. We show how filing a Chapter 13 case, lasting 3 to 5 years, might not be necessary to save your home and its equity even if the amount of that equity is larger than what is protected by your homestead exemption. Chapter 7 may be enough.
Here’s how we introduced the Chapter 7 part of this earlier.
10. Protect Equity in Your Home NOT Covered by the Homestead Exemption
Having too much equity in your home is a problem if you owe a lot to creditors. “Too much equity” means equity more than the amount the homestead exemption protects. Creditors can sue and get judgments against you, resulting in judgment liens attached to that home equity.
If you file a Chapter 7 “straight bankruptcy” case you run the risk of the bankruptcy trustee taking and selling the home to pay the unprotected portion of the proceeds to your creditors. But you may still be able to keep your home.
First, you might be able to claim exemptions in addition to the homestead exemption. Second, you may be able to convince the trustee to accept a deal to let you keep the home.
Here’s how this works in practice.
Assume the following facts:
- You own a home that is worth $250,000.
- Your mortgage loan on that home is $180,000, so you have equity of $70,000.
- The homestead exemption available to you is $50,000. This means that you can protect that much of your home equity. (The homestead exemption amount varies greatly from state to state. But assume it is this amount for this example.)
- You owe $75,000 in credit cards and personal loans, plus $20,000 in medical bills, totaling $95,000.
- During the last couple of years your income has decreased and your medical and other expenses have increased. So for the last year or so you haven’t been able to pay the minimum amounts on many of your debts as they came due. One collection company has just sued you for $7,500, and others are threatening to do so very soon.
Losing Your Home Equity Without Bankruptcy
Unless you have some defense to the $7,500 lawsuit, the collection company will likely get a judgment against you within a few weeks. In most states that would quickly turn into a judgment lien against your home.
That creditor may be able to foreclose on the judgment lien, forcing you to pay to not lose your home. The judgment lien encumbers your title, reducing the equity you have in the home. The underlying judgment debt continues earning interest. At best it would have to be paid off whenever you refinance or sell your home.
Your other creditors would also be motivated to sue you. That’s because even after the $7,500 judgment lien, you still have more home equity that could be attached. You and your home are sliding downhill fast.
Protecting Home Equity with Chapter 7
Assuming you want to keep you home and the equity you have in it, Chapter 7 provides some help. Under the right circumstances that help may be enough.
If you and your Louisville bankruptcy lawyer file it fast enough, the collection company would not get a judgment. So, no judgment lien on your home. These are good things.
And most likely that $7,500 debt would be legally written off, and usually only 3-4 months after the bankruptcy filing. Furthermore, most likely all of the $95,000 in credit card, medical, and other debts would be written off. Another good thing.
So what’s the problem? The problem is that Chapter 7 is a “liquidation.”
In most Chapter 7 cases nothing the debtor owns gets “liquidated”—taken, sold, and the proceeds paid to creditors. Nothing is taken because in most Chapter 7 cases everything that the debtor owns is “exempt.” That means it’s protected both from your creditors and from the bankruptcy trustee, who works on behalf of the creditors.
But under our facts your home is not fully exempt. The homestead exemption protects only $50,000 of the $70,000 of equity. The Chapter 7 trustee could take and sell the home, pay you your $50,000 homestead exemption, and divide the remaining proceeds of the sale among your creditors. How could you avoid this, keep your home, and write off all your debts? How could you do this without being in a Chapter 13 case for 3 to 5 years?
1) Possibly Apply Other Exemptions
In some states and under some circumstances, you may have other exemptions that you could apply to your home on top of the homestead exemption. Some states provide a relatively large floating exemption that you can add to the homestead exemptions. That may eat up enough of the remaining equity that the trustee is persuaded it’s not worth taking and selling the home.
2) Negotiate with the Chapter 7 Trustee
The trustee is not particularly interested in taking your house. He or she just wants to pay your creditors what the law provides. Under the right circumstances, deals can be struck with the trustee.
In our example, let’s assume that the trustee would agree that the home’s fair selling price would be $250,000. But after paying the mortgage lender $180,000 and $50,000 to you, the trustee wouldn’t actually have $20,000 to distribute to your creditors. There would be selling costs that would cut into that. The realtor’s commission at about 6% is $15,000. Other selling and closing costs would likely eat up all or most of the remaining $5,000.
At this point the trustee may simply agree that selling the home “would not result in a meaningful distribution to the creditors.” That is, there’s a good chance that after much effort there would be little or nothing for the creditors.
Or the trustee may push to get something out of you in return for not selling the home. The trustee may argue, and even get a realtor’s estimate, that the home could sell for $255,000 or $260,000. So the trustee may agree to let you keep the home if you agreed to pay $5,000 or $10,000. You would likely get a year or so to pay it. If you could afford the monthly payments, or had a source for that kind of money, that may be better than a much longer lasting Chapter 13 case.
For the sake of comparison, and in case the Chapter 7 option would simply not work, see our next blog post for how a Chapter 13 could solve this problem better.