Chapter 7 and Chapter 13–Selling Your Home with Equity but Have Lots of Other Debts
Oct. 28, 2015
Protect the equity in your home from your creditors through either of the consumer bankruptcy options.
If you have some equity in your home bankruptcy may enable you to keep that equity—to help your transition into a rental, to buy another home, or to put it into retirement.
Today we’ll look at how that works under a Chapter 7 “straight bankruptcy” and then next time under Chapter 13 “adjustment of debts.”
If you have some equity in your home and you owe more other debts than you can handle, that equity is likely in jeopardy. Your creditors and debt collectors can easily find out about that equity and are all the more quick to sue you in order to latch onto it. In most states a lawsuit that turns into a judgment becomes a lien on your home. That means that once the lien is recorded, when you sell your home the debt has to be paid in full, usually with a large amount of additional fees added to it.
Judgment liens must generally be paid in the order that they are recorded, which motivates creditors to sue you and get their judgment before other creditors.
Depending how much equity you have, you could easily lose all your equity and potentially still owe a lot of unpaid debt. That’s because the earlier judgments are paid in full until the equity runs out, leaving other creditors unpaid—those who’ve sued you and those who haven’t.
So when you sell your home you can end up with no equity, no home, and still a lot of debt.
Chapter 7 and the Homestead Exemption
Our last blog post was about what happens under Chapter 7 and Chapter 13 if you have “too much” equity in your home, meaning more equity than is protected through your homestead exemption. Today we assume you have no more equity than is protected by the homestead exemption. Generally you would be filing a Chapter 7 case only when that is true. (Please see our last blog post for a rather thorough explanation of homestead exemptions.)
A Chapter 7 case usually takes only 3 or 4 months to complete. During that time the Chapter 7 trustee determines, on behalf of all your creditors, whether the amount of equity in your home is indeed no more than is protected by the applicable homestead exemption. As long as you and your attorney have prepared the case appropriately this will not be a problem.
Assuming the trustee agrees that the home and its equity is exempt and protected, you will be able to keep the home and the equity in it. Either all or most of your other debts will be discharged—permanently legally written off—so those creditors can never again pursue the equity in your home.
Stopping Judgment Liens from Hitting Your Home
If you are currently being sued, or are concerned that you will be, filing a Chapter 7 case will stop an ongoing lawsuit from going forward and will prevent a new lawsuit from being filed against you. That means that as long as the debt is one that will be discharged in a Chapter 7 bankruptcy (which includes the vast majority of debts), a judgment will not be entered against you and a judgment lien will not be recorded against your home. So your equity will be protected.
Getting Rid of Judgment Liens So You Get the Home Equity
About two weeks ago we explained how certain judgment liens can be “avoided,” or nullified, even after being recorded against your home. Unlike many bankruptcy tools affecting your home which can only be used under Chapter 13, judgment lien “avoidance” is available under Chapter 7 as well.
So if you currently have one or more judgment liens against the title of your home, filing a Chapter 7 case could well take the anticipated proceeds of sale of your home out of the pockets of these “judgment lien creditors” and give that money to you instead.
Getting Rid of Oher Debts So That You Keep the Equity
Since your debts will be discharged in a Chapter 7 case so quickly (or at least most of your debts, and often every one that you want discharged), you will be able to keep all of the proceeds of sale when you sell your home after the bankruptcy case is finished. You won’t have to spread it out among your creditors.
That means that if you need the sale proceeds to move to a rental home or apartment, or to buy a manufactured home or even a mobile home to live in (or how about a boat!), you will be able to.
You may instead want to use that money to pay off a vehicle, to pay for some transition training or education, or possibly to supplement an inadequate amount of retirement funds. If you and your attorney structure it right, you would likely be able to use the money for these purposes.
Selling Your Home before/after the Chapter 7 Bankruptcy
You DO need to be careful about some timing issues, and sometimes about the uses of the proceeds of sale. For example, in some states you could have already sold your home BEFORE the bankruptcy was filed and the homestead exemption might still protect the sale proceeds, but only under certain conditions. You might have to use the sale proceeds for a new homestead, but that may be broadly interpreted to include advance home rental payments or a mobile home you intend to live it.
These kinds of issues turn very much on the details of the homestead exemption(s) applicable to your case—potentially either your local state law or federal law. You clearly want to get advice from an attorney who specializes in consumer bankruptcy law and deals with these kinds of issues all the time.