Your Home in Chapter 7 Bankruptcy
What happens if you own a house and file for Chapter 7 bankruptcy?
Whether Chapter 7 bankruptcy makes sense when you own a home depends on your goals do you want to save your house, delay foreclosure, or just walk away with less debt? Most Chapter 7 bankruptcy filers can keep their homes as long as they are current on their mortgage payments. A few lose their home if they have significant equity that can be used by the trustee to pay unsecured creditors. For those planning on walking away from the home, Chapter 7 bankruptcy can delay foreclosure for a short period of time. (To learn about the basics of Chapter 7 bankruptcy, see Nolo's article A Chapter 7 Bankruptcy Overview.)
Read on to learn more about what will happen to your home in a Chapter 7 bankruptcy.
Can I Keep My Home?
You will be able to keep your home in Chapter 7 bankruptcy if you have no equity in the house or you are able to exempt (protect) whatever equity you do have in your home, using the homestead exemption (discussed below). If this is the case, the bankruptcy trustee cannot sell your home to pay unsecured creditors because there would be no money to distribute.
However, it is important to distinguish between losing your home in bankruptcy (which happens when the bankruptcy trustee sells your home to pay unsecured creditors) and losing your home outside of bankruptcy (that is, through the normal foreclosure process). If you are behind on your mortgage payments, you will eventually lose your home in foreclosure outside of the bankruptcy process, even though the bankruptcy trustee does not sell your home as part of the bankruptcy.
If You Are Behind on Your Mortgage
If you file for Chapter 7 bankruptcy and want to keep your home, you must keep making your mortgage payments. In most cases, the bankruptcy trustee will not sell your home (see "Will You Lose Your Home in Bankruptcy?", below), but once the bankruptcy is complete, the normal foreclosure process will proceed. (Or, if the lender is able to lift bankruptcy's automatic staydiscussed belowthe foreclosure process could start before the bankruptcy is over.) That would mean that you'd lose your home outside of the bankruptcy process, through foreclosure.
If you have a mortgage arrearage and want to save your home, consider Chapter 13 bankruptcy, which can allow you to pay off the arrearage through the bankruptcy. (To learn how Chapter 13 bankruptcy affects your home, see Your Home in Chapter 13 Bankruptcy.)
Will You Lose Your Home in Bankruptcy?
Even if you are current on your mortgage payments and can continue to make them in the future, you may still lose your home if the bankruptcy trustee is allowed to sell it. If you have significant nonexempt equity in your home, the Chapter 7 bankruptcy trustee may attempt to sell your home in order to pay off some of your unsecured debt. However, most Chapter 7 bankruptcy debtors don't have enough nonexempt equity to trigger a sale, which means most debtors can keep their homes in bankruptcy. To determine if the bankruptcy trustee is likely to sell your home, go through this two-step process:
Step One: Determine the Amount of Your Homestead Exemption. The laws of most states allows homeowners to protect a certain amount of the equity in their home from creditors this is called the homestead exemption. To figure out the amount of your homestead exemption, you must determine which set of exemptions apply to you. There is a federal homestead exemption (which can be used only in some states), and most states have a homestead exemption amount (usually based on dollar value, but some states limit the amount of acres you can protect from creditors). Which exemption you can use depends on where and when you bought the home, whether the state where you are filing allows use of the federal exemptions, and whether you have moved within the last few years. To learn the details of the homestead exemption amounts, consult with an attorney or a good self-help bankruptcy book. (For information on bankruptcy attorneys and books, see "Getting Help" at the end of this article).
Step Two: Is There Enough Unprotected Equity In Your Home to Trigger a Sale? Next you must determine if you have enough nonexempt equity (equity not protected by the homestead exemption) in your home to trigger a sale in bankruptcy. Start with the market value of your home and subtract the following:
- the amount of homestead exemption you are entitled to claim (usually between $10,000 and $100,000)
- the trustee's commission on the difference (25% of the first $5,000, 10% of the next $50,000, and 5% of the rest, up to one million)
- the costs of sale (usually around 8% of the market value)
- the amount owed on all mortgages, and
- the amount of all nonmortgage liens secured by the home (such as a tax lien).
If you end up with a negative number, you do not have sufficient equity to trigger a sale. This essentially means that the Chapter 7 bankruptcy trustee will have no incentive to sell your home, since there won't be anything leftover to be used to pay the unsecured creditors.
If you end up with a positive number, this is the amount of equity that the bankruptcy trustee could use to pay your unsecured creditors. In this case, the Chapter 7 bankruptcy trustee may sell your home, give you the amount of the homestead exemption, pay off mortgage and lien holders, and use the rest to pay off unsecured creditors.
When you file a Chapter 7 bankruptcy petition, most creditors are instantly prohibited from continuing collection efforts against you. This is called the "automatic stay."
The automatic stay does apply to foreclosures your lender must cease foreclosure efforts while your bankruptcy is in progress (but the lender can continue to foreclose once the bankruptcy is completed).
However, your lender can (and probably will) ask the court to lift the automatic stay before your bankruptcy is completed. If the lender can prove that it is the legal holder of the mortgage or deed of trust to your home, the court will most likely lift the automatic stay and allow the foreclosure to proceed.
Although you might think that your lender/the foreclosing company can easily prove that it owns the mortgage or deed of trust, this is not always the case. Because mortgages have been bought, sold, lumped together, and electronically repackaged frequently in recent years, the institution trying to foreclose may not be able to provide the required proof to the court. If so, the automatic stay will remain. While this may seem like a victory, you will likely only gain an additional month or two delay, because the judge decides whether to lift the automatic stay a couple of months into the bankruptcy, and the bankruptcy itself usually only lasts three and a half months.
Nevertheless, delaying foreclosure by even a few months can be financially advantageous to the homeowner. For instance, if your mortgage payment is $2,000 a month, you can save $6,000 or $7,000 just in that short period by not having to make payments.
Even if the lender is successful in lifting the automatic stay, you will likely get an additional number of free months in the home, due to delays that are part of the normal foreclosure process and the failure of the bank or new owner to immediately take the steps necessary to evict you. (To learn more about the automatic stay, see Nolo's article How Bankruptcy Stops Your Creditors: The Automatic Stay.)
Cancellation of Other Debt Means More Money for Your Mortgage
If you are current on your mortgage and your home isn't worth enough to trigger a sale in your bankruptcy (see "Will You Lose Your Home?", above), then the cancellation of other unsecured debt in a Chapter 7 bankruptcy can help you stay in your home by freeing up money that you can then use to pay your mortgage.
Tax Advantages If Your Home is Sold in Foreclosure
Chapter 7 bankruptcy will cancel your mortgage and all other debts secured by your home, such as a home equity line of credit even though the liens created by these debts will remain in place. This has distinct tax advantages if you lose your home in foreclosure.
Normally, if you lose your home in foreclosure and the amount the lender gets in the foreclosure sale doesn't cover the amount remaining on your loan, the difference is treated as "forgiven debt." However, since there is no debt after bankruptcy, there is no "forgiven debt" to tax. (Even if you incur a forgiven debt tax before you file for bankruptcy because of a previous foreclosure, other rules make payment of the tax unlikely.) To learn more about this exception, see Nolo's article Short Sales and Deeds in Lieu of Foreclosure.)
Getting Help
If you plan to file for Chapter 7 bankruptcy but want to keep your home or if you have questions about how your home will be treated in Chapter 7 bankruptcy be sure to consult with a bankruptcy attorney or a good self-help bankruptcy book. The rules regarding homestead exemptions and domicile (residency) requirements can be tricky, and forcing a foreclosing institution to prove it owns the mortgage or deed of trust probably requires the help of a lawyer. For a comprehensive explanation of the law and step-by-step help with filing for Chapter 7 bankruptcy, get How to File for Chapter 7 Bankruptcy, by Stephen Elias, Albin Renauer, and Robin Leonard (Nolo). If you are trying to save your home and are in jeopardy of foreclosure, get The Foreclosure Survival Guide, by Stephen R. Elias (Nolo).
For help on choosing a good bankruptcy lawyer, visit Nolo's Lawyer Directory, where you can view in-depth attorney profiles of attorneys in your local area.
Nolo. (Reviewed 2016). Your Home in Chapter 7 Bankruptcy Retrieved 7/7/2016 from http://www.nolo.com/.