How to Declare Bankruptcy and Not Lose Your Home Equity

by Neal Frankle, CFP ®

You can declare bankruptcy and not lose your home equity. Let me illustrate how by answering an e-mail I received from “B.”

My husband and I run a small real estate business. We thought this was one of the best business ideas we could come up with. But when the “housing bubble” began to burst we had three spec homes on the market for sale. We had to borrow against our home to keep our houses and use credit cards to help pay our personal bills.

After we sold the spec homes, we ended up with a debt of $30,000 on credit cards and a whopping $45,000 in equity loans against our home.

Now we don’t know what to do.

We have three young kids. If we sell our house we might make enough to pay back everything, but we don’t know where to go from there. No one is going to lend us money for a new mortgage and our current mortgage payment is not affordable.

I am afraid of losing our home if we file for bankruptcy and never being able to get a mortgage with bad credit ever again. Help!

There’s a lot going on there for a busy little Pilgrim like me. For today, let’s focus on the real estate question:

I’m going to assume that you’ve already tried to modify your loans and the creditors aren’t working with you. I’m also going to assume that your current mortgage would be affordable if your other debts were discharged.

“B,” you have a few options.

If you want to hold on to your home and NOT file for bankruptcy, go to your creditors and negotiate hard. Try to get them to reduce your payments and interest rates. Get them all to modify the loans. It’s beyond the scope of this post to discuss this process. I’m going to assume you’ve already done that. I’m going to do a special post on loan modification in the future just in case…stay tuned.

Keep in mind that even if you do this, your credit is probably going to take some hits and that probably will hurt your credit score range and future investment ability. But right now, I wouldn’t worry about future investment opportunities. I’d focus on getting out of the situation you’re in now.

Let’s look at filing for bankruptcy and holding on to your home equity.

You have two options. But you have to understand the difference between chapter 7 and chapter 13 bankruptcy.

The first option is to file chapter 7. This would get you out from under your debts, but you have to be very careful.

The only way you’ll be able to hold on to your home is if:

a. There is no equity and the bankruptcy trustee “abandons” the property. That means that the trustee realizes the equity is so low it’s not worth it, so she doesn’t go after the property. In this case, you still have to make mortgage payments but you could get relief from your other debts.

b. You have equity, but it’s below the “exemption” amount. Every state has a bankruptcy “exemption” amount which you can take advantage of. So, if your state has an “exemption” amount of $75,000 and the equity in your home is $75,000, you can keep your home even though it has equity and still declare chapter 7 bankruptcy to get relief from the other debt.

Another option is to declare chapter 13 bankruptcy. This is a workout plan rather than a way for you to get a clean slate. You would go this route in case you don’t qualify for option “a” or “b” above.

Chapter 13 will help you work out your debts – not relieve you of them. But this route could help you get some breathing space.

Either way, you’re going find it difficult to get credit, so be ready for that.

Tomorrow, I’m going to look at her equity line and other items to help “B.”

 

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