What Happens with a HELOC in Bankruptcy?

Debt from a home equity line of credit is discharged in bankruptcy, but the lender may foreclose depending on the circumstances.

By , Attorney · Northwestern University School of Law

How a home equity line of credit (HELOC) is treated in bankruptcy depends on what type of bankruptcy you file -- Chapter 7 or Chapter 13.

What is a HELOC?

A home equity line of credit, or HELOC, is a line of credit, which is borrowed on an "as needed" basis. It works much like a credit card. It is also sometimes used mistakenly to refer to a "home equity loan." A home equity loan is different from a HELOC; it is a loan received in full, up front and paid back by fixed, scheduled payments.

The HELOC in a Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy, the bankruptcy trustee liquidates unsecured assets to pay creditors. However, because bankruptcy law "exempts" certain types of property up to certain values from liquidation, the vast majority of debtors who file for Chapter 7 are allowed to keep all of their property. After your Chapter 7 filing, you receive a discharge from most of your debts. (To learn more about how Chapter 7 works, see the articles in the Chapter 7 Bankruptcy area.)

Discharge of Personal Liability for HELOCs

When you receive your Chapter 7 discharge, your personal liability to pay back your HELOC is wiped out. However, because your HELOC is a secured debt (which means you pledged your home as collateral for the debt), if you want to keep your home, you'll still have to make payments on your HELOC. Here's why. Even though your personal liability is discharged, the bank still has a lien against your home and retains its right to foreclose against your home if you fail to make the monthly HELOC payments.

The discharge of your personal liability for the loan is important, however. If the bank does foreclose on the lien, and there is a deficiency balance (which may happen if you are underwater on your home loans), you won't be liable for that balance.

HELOCs and Foreclosure in Chapter 7

If you are behind on your HELOC payments, in theory, a Chapter 7 filing will not prevent foreclosure. (Keep in mind that the bankruptcy's automatic stay is temporary.)

However, in the real world, your HELOC lender will typically not foreclose if it is not likely to be paid a meaningful amount after the foreclosure sale. Because a HELOC is almost always the second mortgage, the proceeds from the foreclosure sale would first be used to pay off the first mortgage lender (called the senior mortgage). If, after deducting the costs of the foreclosure sale and paying off the first mortgage, there is little left for the HELOC lender, it has little incentive to go through with the foreclosure. This may buy you time to work out an arrangement with the lender, or to refinance your mortgage (which you often can do a few years after your bankruptcy filing).

The HELOC in a Chapter 13 Bankruptcy

In Chapter 13 bankruptcy you keep your property and repay your debt (some in full, some in part) over three or five years. (To learn more about Chapter 13, see the articles in the Chapter 13 Bankruptcy area.)

Chapter 13 provides two advantages in dealing with a HELOC in certain situations.

Stripping Off HELOCs in Chapter 13

If the market value of your home is less than the balance on your first mortgage, you can "strip off" (remove) the HELOC. The HELOC loan amount is treated like other unsecured debts (e.g. credit cards) in your Chapter 13 Plan. Most Chapter 13 filers pay pennies on the dollar when it comes to unsecured debt. At the end of the plan, you receive a discharge of liability for any unpaid balance due the unsecured creditors, including the HELOC. In addition, the lien securing the HELOC is removed, which means your home is only subject to the first mortgage going forward. (To learn more about how this works, see Removing a Second Mortgage in Bankruptcy.)

Curing Mortgage Arrearages in Chapter 13

Chapter 13 also allows you to cure a HELOC arrearage in your plan and prevent foreclosure. For example, if you are $3,600 behind on your HELOC payments when you file your Chapter 13, you can cure the arrearage in a 36-month plan by paying $100 per month into your plan. You don't have to get bank approval of this; if the court approves your plan the bank must accept the terms. At the end of the plan, you will be current on the HELOC.

It is important to remember that in addition to the Chapter 13 plan payment, you will be required to make the regular monthly HELOC payments, beginning with the first payment due after your bankruptcy filing date. Also, depending on your income and other factors, the length of the plan may be 60 months.

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