Protecting Your Home Equity through Chapter 7

Protecting your home equity is possible if the amount of equity is no more than the homestead exemption. 

Our last two blog posts (More Bankruptcy Benefits; Bankruptcy’s Many

Benefits for Your Home)  outlined 15 separate ways that bankruptcy can protect your home now and in the future. We’ll be explaining each one of these ways in 15 different blog posts. Here is the first one—protecting present and future equity in your home through Chapter 7, “straight bankruptcy.”

Property Exemptions in General in Bankruptcy

When you file a bankruptcy case, exemptions protect certain assets.  Exemptions are categories of your assets that protect you from your creditors. Each exemption usually has maximum dollar limits. (See Section 522 on “Exemptions” in the U.S. Bankruptcy Code.)

Exemptions work somewhat differently in Chapter 7 and Chapter 13. Focusing today on Chapter 7, this is a liquidation form of bankruptcy. A liquidation means in theory that the Chapter 7 trustee takes—liquidates—anything you own not fitting within an exemption. 

However, the practical effect of exemptions is that most people filing under Chapter 7 get to keep everything they own.

Protecting your Home Equity: Homestead Exemption

The homestead exemption determines how much equity in your home you can protect from your creditors. As long as the amount of equity is no more than the homestead exemption amount, your home is safe in a Chapter 7 case.

As a quick example, assume your home is worth $300,000, you owe $265,000, so you have equity of $35,000. If the applicable homestead exemption in your state is $35,000 or more, your home is protected.

This means that your Chapter 7 trustee can’t take several home and sell it to pay the equity over to your creditors.

If you have too much equity, you probably should not file under Chapter 7. Not if you want to keep your home. See next week’s blog post about preserving home equity that’s more than your homestead exemption through Chapter 13.

Federal vs. State Exemptions

Bankruptcy law provides a set of federal exemptions, while each state has its own set of exemptions as well. All have a homestead exemption. Can you use either the state or federal homestead exemption? If so, which should you use?

At the outset, since bankruptcy is a federal procedure, why is state exemption law applicable at all?

The U.S. Constitution made bankruptcy procedure uniform throughout the country.  See Article I, Section 8, Clause 3 of the Constitution. But there are many areas in bankruptcy where state laws apply. One such broad area is property law. In an compromise, Congress gave each state the power to require its residents to use that state’s set of exemptions instead of the federal ones. Section 522(b)(2) of the Bankruptcy Code.

So 31 states have decided you must use the state law exemptions. Montana is one of those states. In the remaining 19 states, you can use either the state or federal bankruptcy exemptions. Since the list is shorter, these 19 states that give you a choice are:

Alaska, Arkansas, Connecticut, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.

The Amount of Your Homestead Exemption

The homestead exemption amounts vary greatly state to state. For example, Kentucky’s homestead exemption protects only $5,000 in value or equity for an individual homeowner. On the opposite extreme, Nevada’s homestead exemption is $550,000. Plus a number of states—including Texas and Florida– have no dollar limit at all (although the exemptions have acreage limitations). Montana’s exemption is $250,000.00, but you must file a homestead declaration for the exemption to take effect.

Dealing with a homestead exemption can be quite complicated. If you are in a state where you can use the federal homestead exemption, you can’t use any of the state exemptions that might be better for another category of assets. Section 522(b)(1) of the Bankruptcy Code. In the example of Nevada and Florida residents, who have such an extensive or unlimited homestead exemption, if they use that advantageous state homestead exemption, they must use their state’s exemptions even if the federal ones may be better in other property categories.

Also, you can’t move to a new state and immediately claim that state’s generous homestead exemption. You must be domiciled in your new State for 730 days, or two years. Section 522(b)(3) of the Bankruptcy Code. If you have lived in two states over 730 days, there are other date deadlines that you must follow.

Finally, a federal cap limits the homestead exemption that can be claimed when you buy your within 1,215 days (3-years and 4-months) before filing bankruptcy. Section 522(p) of the Bankruptcy Code. Effective April 1, 2019 (and for 3-years after that), this cap amount is $170,350. This cap is relevant only if your state homestead exemption is larger than this relatively large amount.

Need Legal Advice

There are other potential complications, depending on your situation. For example, what qualifies as a “homestead?” What if you are purchasing a home on contract, or have a leasehold interest, or jointly own the property?

Your homestead exemption situation may be very straightforward. But it may not be, even when it seems like it is. You need to get legal advice about this. It would be one of the first topics you would cover with your Kalispell bankruptcy lawyer.

Bankruptcy—including Chapter 7—can be a great way to protect present and future equity in your home. But it’s crucial to know for sure which homestead exemption applies to you and whether it will protect your home.