If your home is exposed to your creditors and to the Chapter 7 trustee because it has too much equity, Chapter 13 can protect that equity.
In our July 1 blog post we gave a list of 10 ways that a Chapter 13 “adjustment of debts” case can help you keep your home. Today we’re on the 10th one on that list. This one’s about saving your home and its equity when that equity is larger than the allowed homestead exemption.
We took a detour in our very last blog post by showing how sometimes filing the simpler Chapter 7 case can still let you keep your home in this situation. But the circumstances that will work are quite rare. So it important to understand how to protect otherwise unprotected equity through Chapter 13.
Here’s how we introduced this earlier as it pertains to Chapter 13.
10. Protect Equity in Your Home NOT Covered by the Homestead Exemption
Having too much equity in your home is a problem if you owe a lot to creditors. “Too much equity” means equity more than the amount the homestead exemption protects. Creditors can sue and get judgments against you, resulting in judgment liens attached to that home equity.
If you file a Chapter 7 “straight bankruptcy” case you run the risk of the bankruptcy trustee taking and selling your home to pay the unprotected portion of the proceeds to your creditors.
Under a Chapter 13 “adjustment of debts,” in contrast, you can keep and protect the home and its equity. You pay a certain amount of those debts gradually over the course of the up-to-five-year Chapter 13 case.
Here’s how this works in practice.
Assume the following facts:
- You own a home that is worth $275,000.
- Your mortgage loan on that home is $195,000, so you have equity of $80,000.
- The homestead exemption available to you is $50,000. This means that you can protect that much of your home equity. (The homestead exemption amount varies greatly from state to state. But let’s assume it’s $50,000 in this example.)
- You owe $15,000 in income taxes for last year and the year before.
- You owe $75,000 in credit cards and personal loans, plus $25,000 in medical bills. So you have a total of $100,000 in debts other than the home mortgage.
- During the last couple of years your income has decreased and your medical and other expenses have increased. So for the last year or so you haven’t been able to pay the minimum amounts on many of your debts as they came due. One collection company has just sued you for $10,000, and others are threatening to do so very soon.
Summarizing our last blog post, unless you act quickly the collection company would likely get a $10,000 judgment against you. That would likely quickly turn into a $10,000 judgment lien against your home. That creditor may be able to foreclose on that lien, forcing you to pay save your home. At best you’d have to pay off the $10,000 (plus interest) whenever you refinance or sell your home.
Some of your other creditors would very likely also sue and get their own judgment liens against your home.
You and your bankruptcy lawyer would put together a Chapter 13 payment plan. That plan would be based on the principle that Chapter 13 allows you to keep your home even if its equity is not fully protected by the homestead exemption, as long as you follow certain rules. See Section 1325(a)(4) of the Bankruptcy Code.
Essentially, you must treat creditors in a Chapter 13 case at least as well as they would have been treated in a Chapter 7 case. This applies particularly to the $10,000 tax debt and to the $100,000 in other debts.
So here’s what you would provide for in your Chapter 13 payment plan:
- Over the course of your plan you would pay off the $15,000 income tax debt. It’s not old enough to “discharge”—legally write off—under either Chapter 7 or 13. But you would not have to pay any ongoing interest or penalties under Chapter 13 (assuming you finished it successfully). And your payments would be flexible, based on what you could afford to pay.
- You’d pay only as much of the remaining $100,000 as that would have been paid in a Chapter 7 case. Here how that’s calculated, roughly:
- Determine, hypothetically, how much net sale proceeds would come from your home if a Chapter 7 trustee would sell it. The $275,000 sale price would be reduced by about 6%, or $16,500, for the realtor’s commission. Another $3,500 or so would be spent on title insurance, escrow fees, and any other closing costs. (This assumes no need for any repairs or other sale preparation costs.) The $275,000 sale price minus the $16,500 and $3,500 means a net sale price of $255,000.
- Subtract the mortgage amount of $185,000 from this $255,000 net sale price results in sale proceeds of $70,000 in this hypothetical sale.
- Subtracting the $50,000 homestead exemption from this $70,000 leaves $20,000 that you must pay to your unsecured creditors in your Chapter 13 plan.
- $15,000 of that would go to the income taxes.
- That leaves only $5,000 ($20,000 minus $15,000) that you need to pay to the remaining $100,000 of debt. In other words, you would have to pay 5% of those debts.
- Your monthly plan payment would be around $400 per month, for about 60 months. Much of that would go to pay off the taxes, which you’d have to pay after a Chapter 7 case anyway.
- At the end of your case you would have kept your home in spite of it having $30,000 in equity beyond the $50,000 homestead exemption. The unpaid $95,000 of debts would be discharged.
This is quite a good result. Throughout the Chapter 13 case you and your home would have been protected from the tax collector, the suing collection company, and all your other creditors. Then as of the end of the case you’d have paid off the income taxes, and would be (other than the mortgage) completely debt free.