Here’s an example showing why a judgment lien on your home is dangerous, and how bankruptcy can solve this problem.
The last two blog posts have been about judgment liens on a home: the trouble they cause and how bankruptcy gets rid of them.
Today we’ll give examples both of judgment lien trouble and of bankruptcy’s solution.
The Trouble Caused by a Judgment Lien
Brent and Sandra Taylor own a $290,000 home with a $250,000 mortgage. They have a lot of other debt. Besides the mortgage they owe mostly medical bills and credit cards—$80,000 and $55,000 of them, respectively, $135,000 altogether.
One collection agency collecting on $20,000 of the medical bills sued them six months ago. Brent and Sandra didn’t respond to the lawsuit. They figured they definitely owed those medical bills and so had no reason to respond or object. Plus they had nothing to offer in settlement, either as a lump sum or in monthly payments.
They didn’t realize that in their state, like in many states, a judgment automatically turns into a judgment lien on real estate owned by the judgment debtor. The collection company recently informed them there was a judgment lien on their home in the amount of $22,500. The extra amount was for the collection agency’s attorney fees and other legal costs, plus ongoing interest.
The Taylors are now getting calls from the collection agency making them believe they’re going to lose their home. They’ve gotten the impression that the judgment lien can be foreclosed on since they have enough equity in the home to cover it. They’ve been pressured to refinance or sell their home. Because of their debts and inadequate equity, they can’t qualify for any refinancing. So they think they have to sell the home.
Even if the Taylors would somehow succeed in getting refinancing, they would have to pay off the judgment lien from the refinancing proceeds. That would just about wipe out their equity.(Again, this makes a refinancing virtually out of the question.)
Or if they would sell their home, the judgment lien would have to be paid in full out of the sale proceeds. That’s because valid judgment liens must be paid before the homeowners get anything from the property. After paying off the judgment lien and other costs of sale, they would have very little left over to get new housing. Certainly nowhere near enough for the down payment on a home; likely barely enough for a few months of rent.
Brent and Sandra hate the whole idea of selling their home. In their housing market renting would cost more, especially when accounting for the mortgage interest tax deduction. Plus they know it would be many years before they could again qualify for a mortgage, especially with tighter financing standards these days.
Partly Saved by the Homestead Exemption
So they go to see a bankruptcy lawyer. The first thing they learn is that they are entitled to a homestead exemption that provides certain protections for their home equity.
Assume that in their state their homestead exemption amount is $50,000. (These amounts vary widely so you need to find out from an attorney how much you qualify for. Determining this can often be more complicated than you think.)
One protection that $50,000 homestead exemption provides is that the collection agency actually can’t foreclose on the judgment lien. (The collection agency purposely gave Brent and Sandra the wrong impression on this.) The collection agency can’t foreclose because Brent and Sandra have $40,000 in equity ($290,000 home value minus the $250,000 mortgage). All of that $40,000 of equity is protected by the $50,000 homestead exemption.
But that still leaves Brent and Sandra with a judgment lien, increasing over time, which would have to be paid in full whenever they sell the home. And they still also have all the rest of their debts, most of which they are far behind on. Before long will come more lawsuits, and more judgment liens.
Judgment Lien Avoidance
As explained in our last blog post, if the Taylors filed a bankruptcy case, the judgment lien could be “avoided.” It could be completely taken off their home’s title.
That’s because all of that $22,500+ judgment lien “impairs” their homestead exemption. That is, all of the equity that this judgment lien eats into is protected by the Taylor’s $50,000 homestead exemption.
The Good Conclusion
So, if they filed a Chapter 7 “straight bankruptcy” case, most likely Brent and Sandra would be able to discharge (permanently write off) all their $135,000 or so in medical and credit card debts. They would “avoid” the $22,500+ judgment lien so it would be permanently off their home title. Because they want to keep their home they would continue owing and paying their mortgage.
But they would have no other debts, and no judgment lien. Brent and Sandra Taylor would have a fresh financial start.