Bankruptcy is never an enjoyable process. And in some cases, yes, you will not be able to stay in your house. But not in all of them, say experts. Sometimes, filing bankruptcy could be just the ticket for keeping your home.
Exempt vs. Non-Exempt Assets
Bankruptcy is either the liquidation or reorganization of a person's or business's assets in order to pay the claims of creditors. But not everything you own gets treated alike in bankruptcy courts. Federal law exempts certain kinds of assets from seizure to satisfy creditors, including 401(k) plans, pensions, a limited amount of home equity, a limited amount of life insurance, and the like. However, each state has the option to accept the federal limits, or adopt their own. Each state, therefore, has different rules on how much of your home equity is protected from the reach of creditors in a bankruptcy, according to Corey Vandenberg, a bankruptcy attorney in Provo, Utah.
Why Going Bankrupt can Help You Keep Your Home
If you are drowning in debt, and your home is only one of several outstanding balances, and you want to keep your home, filing for bankruptcy may actually help you. Once you file, the court orders what is known as an automatic stay, meaning all collection activities must cease, pending a hearing before a bankruptcy trustee in a federal court. This means most of your payments could be suspended for a while – which could give you the breathing space you need to save some money to get current on your mortgage.
How Badly do You Want It?
First, consider your overall financial situation. Why did you get pushed so far into a corner that you needed to consider bankruptcy in the first place? In some cases, the root causes of a bankruptcy have little to do with the home. If your monthly outlay for shelter – including mortgage payments, property taxes and utilities – is well within your budget, or is not significantly more than you would pay anyway if you gave up the home and went back to renting, then a tactical bankruptcy may make decent sense.
On the other hand, if you simply have too much house for your income, or if your home will shortly need repairs that are beyond anything you can afford – even after you declare bankruptcy and have other debts discharged, you may not want to try to keep the home. It may make better sense to take the foreclosure (or a short sale), and rent for a time while you get a fresh start.
Furthermore, you may want to let the house go if you are simply hopelessly underwater on the home. If you are making $40,000 per year and you owe $200,000 on a home that's now worth $120,000, it doesn't make much sense to commit the after-tax income of over three years of your life just to come back even. Especially in non-recourse states, where lenders have no claim on borrowers' personal assets in the event that a foreclosure sale does not cover the outstanding mortgage balance. You may be better off letting the house go, saving the $80,000, renting for a while, and starting over by eventually buying another home at a more current market price. If your home has no equity, you can keep it in Chapter 7 bankruptcy. The lender still holds the security interest, although the note is wiped out.
Do I Qualify?
Although bankruptcy hearings occur under the purview of the federal court system, states are generally free to set their own limits on what bankruptcy filers are allowed to keep. In Florida and Texas, for example, you can keep an unlimited amount of home equity in a Chapter 7 proceeding. But you may also have to meet strict limits on your income to qualify for a Chapter 7 full discharge. Other states limit the amount of equity you can retain. For example, in Illinois, you are allowed to keep your home if you have $15,000 or less in equity in your house ($30,000 for married couples.) If you have more than this amount, your creditors could demand that bankruptcy trustees sell the house and pay them off with the proceeds.
If you have at least some income, it is much easier to qualify for a Chapter 13, which is an individual workout. Chapter 13 allows you to restructure your debt and pay at least some of your debt off over about three to five years.
Because state laws vary substantially, it's important to consult with an attorney licensed in your state prior to declaring bankruptcy.
Work out a Deal
Frequently, you can still work out a deal with the lender, depending on the circumstances and whether it makes sense for you to fight to keep the house. With Chapter 7 – a full discharge – filing for bankruptcy only halts the foreclosure process temporarily, until the bankruptcy proceeding has run its course. At the end of the process, the lender will continue with the foreclosure – unless you enter an agreement with the lender, reaffirming the debt. Which you may be in a better position to do, once your other payments – business loans, bank loans, credit cards, even a second mortgage - are wiped out. This provision can help you keep a home, car or other vital asset.
A chapter 13 filing halts the foreclosure permanently – provided you keep making the payments agreed to during your chapter proceedings. If you're worried, don't panic, advises Vandenberg. The bankruptcy court system doesn't want you living in a van down by the river, he says. "There's usually some way to figure out a solution."
In most cases, you can keep the house under the following circumstances:
- You are current on the mortgage.
- Your equity in the home is below the exemption limit allowed by state law.
- You reaffirm the debt.
If you are behind on the mortgage payments, or if you own more equity in the house than your state exempts, Chapter 7 might not allow you to keep the house. In that event, if you want to keep the house, you'll need to file under Chapter 13. This chapter will halt the foreclosure process, restructure your debt, and possibly allow you to make payments on the past-due mortgage amount.
Bear in mind, though, that even this will not permanently forestall foreclosure if you can't make the payments. Bankruptcy doesn't eliminate a lien – your lender still maintains their collateral, and the right to foreclose if you default – even after you declare bankruptcy. If you can't make the arrears payment, plus the ongoing mortgage, you may well have your home foreclosed on, anyway.