Chapter 13 can be a highly advantageous way to protect the excess home equity that is above your homestead exemption.
The Problem of Too Much Home Equity
Our last two blog posts were about protecting the equity in your home through the homestead exemption. Two weeks ago was about protecting the current equity; last week about protecting future equity. These blogs failed to address how to protect your excess home equity. Those blog posts assumed that the amount of equity in your home is no more than the amount of your applicable homestead exemption. For example, if your home is worth $500,000, your mortgage is $270,000, that gives you $230,000 of equity. If your homestead exemption is $230,000 or more (Montana has a $250,000 homestead exemption), a Chapter 7 bankruptcy case will protect that equity.
But what if you have more equity in your home than the applicable homestead exemption amount? In the above example, what if you had $280,000 in equity, but your homestead exemption is only $250,000? The bankruptcy trustee could conceivably sell your home if you filed a Chapter 7 case. Your creditors would receive the proceeds of the sale beyond the homestead exemption amount. Presumably, you need relief from your creditors, but you don’t want to give up your home and its equity in return for being free of your debts.
What about getting that equity out of the home through refinancing the mortgage? Well, what if you don’t qualify to refinance your home? You may not have enough of an equity cushion. Or your credit may be too damaged. Or maybe you’d be eligible for a refinance, but it still wouldn’t get you out of debt. That would not be a good option. So what do you do instead to protect your home and that equity?
Chapter 13 Way to Protect Excess Home Equity
If your home equity is larger than your applicable homestead exemption, then filing a Chapter 13 case can usually protect it. Chapter 13 “adjustment of debts,” protects excessive equity better than Chapter 7. Essentially Chapter 13 gives you time to comfortably pay your general creditors for being able to keep your home.
Why do you have to pay your creditors to be able to keep your home? Remember, if your home equity is larger than your homestead exemption, the alternative is having a Chapter 7 trustee sell the house to get the equity out of it to pay to your creditors. Chapter 13 is often a tremendously better alternative, as we’ll explain here. Also, see Section 1325(a)(4) of the Bankruptcy Code.
Gives You Time to Comfortably Pay
Consider the example above about having $5,000 of equity more than the amount protected by the homestead exemption. Chapter 13 would give you three to five years to pay that $5,000. This payback would be part of a monthly payment in your Chapter 13 payment plan. $5,000 spread out over three years is about $139 per month. Spread out over five years is only about $83 per month. Assuming this was part of a monthly payment that reasonably fit into your budget, wouldn’t it be worth paying that to your general creditors if it meant keeping your home and all of its equity?
It’s likely more complicated than this in your situation. You may be behind on your mortgage payments, owe income taxes, or have countless other typical complications. But at the heart of it, Chapter 13 can protect your equity flexibly. It’s often the most practical, financially most feasible way.
Chapter 13 is Flexible
To demonstrate Chapter 13’s flexibility, let’s add one of the complications we just mentioned: being behind on your mortgage. Chapter 13 usually allows you to catch up on your mortgage first. So, for example, most of your monthly plan payment could go there during the first part of your case. Then after that’s caught up, most of the remaining payments could go to cover the excess home equity.
Protecting Your Excess Home Equity “For Free”
Sometimes you don’t have to pay your general creditors anything at all to protect the equity beyond your homestead exemption. Consider the example we’ve been using with $5,000 of excess equity. Now, using another complication mentioned above, assume you owe $5,000 in new income taxes. That tax is a nondischargeable” debt, one that is not written off in any bankruptcy case. It’s a “priority” debt, one that you’d have to pay in full during a Chapter 13 case. If you pay all you can afford in your Chapter 13 plan, and it’s just enough to pay your $5,000 priority tax debt, nothing gets paid to your general creditors. You pay the priority tax debt in full before you have to pay a dime to your general creditors. If there is nothing left for the general creditors after paying all that you can afford to pay during the required length of your payment plan, you likely won’t need to pay those debts at all.
In this scenario, you saved the equity in your home by paying the $5,000 into your plan to pay off the tax debt. That’s a debt you’d have to pay anyway. You’d have to pay it if you didn’t file any bankruptcy case. You’d have to pay it after completing a Chapter 7 case because it does not get discharged. And it also has to be paid in a Chapter 13 case. But in a Chapter 13 case, you fulfill your obligation to pay the $5,000 (in our example) to protect your home equity (the amount above the homestead exemption), whether it goes to the pay the tax or goes to pay the general creditors. Under the right facts, you save your home and pay nothing to your general creditors.
Chapter 13 can be an extremely good way to keep a home with more equity than the homestead exemption amount. At worst, you’d pay the amount of equity over the exemption amount. But you would do so based on a reasonable budget, with significant flexibility about the timing of payment. At best, you wouldn’t pay anything to your general creditors, when the money instead goes to a debt you must pay anyway, like the recent income tax debt in the example.
These situations depend on the unique circumstances of your finances. See a highly competent Kalispell bankruptcy lawyer so you can receive thorough advice about how your conditions apply under Chapter 13.