What Happens With a HELOC in Bankruptcy?

Understanding how a home equity line of credit or "HELOC" can affect your home ownership in bankruptcy is crucial when you want to keep your home. Although a HELOC is a line of credit a borrower can use as needed, much like a credit card, that's where the similarity to a credit card ends.

A HELOC has a much more significant impact in bankruptcy because the borrower's home equity guarantees the loan. As a result, bankruptcy treats a HELOC like a mortgage or home equity loan. Even though Chapters 7 and 13 will "discharge" or erase a HELOC, almost all filers must continue paying the HELOC and mortgages to prevent losing their home.

Learn when you can file for Chapter 7 with a HELOC and keep your home and when your only option will be filing for Chapter 13. Also, learn about other requirements you must meet to avoid losing a residence in bankruptcy.

Choosing Chapter 7 or 13 Matters With a HELOC

A HELOC won't have much impact on your bankruptcy case if you don't want your home anymore. The process is simple. You can file for Chapter 7 or Chapter 13, surrender the house to the lender, and discharge what you owe.

If you want to know what you must do to keep a home with a HELOC in bankruptcy, here's the short answer: If you're current on your mortgage and HELOC payments and can protect all home equity with a bankruptcy exemption, you can keep your home in Chapter 7. If you're behind on a home mortgage or HELOC, or if the house has more equity than you can protect with a bankruptcy exemption, Chapter 13 might help, but it will depend on whether you can afford the monthly plan payment.

Keep reading to learn about HELOCs, including what will happen to the loan and your home in bankruptcy.

Why You'll Lose a Home If You Don't Pay a HELOC: The Lien

A HELOC works much like a home mortgage in a critical way—if you don't pay it, you'll lose the house. Like your home mortgage, a HELOC has two parts—a contract requiring you to repay the debt and a "lien" allowing the lender to take the home if you don't.

The lien creates a "secured" debt because the lender gets an interest in the house until you pay it. If you don't pay as agreed, the lender can use the lien to foreclose on the home, sell it, and use the proceeds toward the balance, making it a potent collection tool for the lender.

The lender has another option, too. It can wait for you to sell the house and get paid with interest, which you'll have to do before transferring a lien-free ownership title to the new buyer.

How HELOCs Work in Bankruptcy

Chapters 7 and 13 automatically erase the HELOC contract that obligates you to pay the debt. However, the voluntary lien you gave the lender in exchange for the HELOC doesn't go away in bankruptcy.

Because of the lien, if you want to keep the house, you must pay the HELOC (below, we explain a Chapter 13 exception that exists but isn't often used because filers can rarely meet the criteria). If you don't pay, the lender can recover the home—even in bankruptcy.

One of the problematic aspects of homes in bankruptcy is the amount of rules that must be satisfied to keep them. For instance, what you must do to keep a HELOC home from the lender differs in Chapters 7 and 13. However, you also have the Chapter 7 trustee and the Chapter 13 bankruptcy judge to satisfy, and each uses an entirely different set of rules when determining whether you can keep your home.

HELOCs in Chapter 7 Bankruptcy

People who don't have extra funds to repay creditors file for Chapter 7 bankruptcy. Qualified debts are erased or in a process that takes about four months, with no money paid to creditors.

One limitation of Chapter 7 is that it doesn't have a mechanism for payment plans. Filers behind on a mortgage, HELOC, or other lien-related debt can't use Chapter 7 to keep a property because, without a payment plan, they can't catch up on missed payments. This inability can present a problem for a Chapter 7 filer who isn't current on a HELOC or mortgage but wants to keep the home.

The takeaway? If you're behind on a mortgage or other debt secured by your home, including, but not limited to, a HELOC, you'll likely lose the house. Unless you can catch up quickly—which would be unusual because if you could, you would before filing—the lender can take steps to recover the home.

For instance, the lender can ask the court to lift the automatic stay that stops creditors from collecting during bankruptcy and allow foreclosure to proceed. The lender's other option is to foreclose after the bankruptcy ends.

Other Chapter 7 Requirements for Saving a Home

Being current on the HELOC and other mortgages protects you from losing the home from the lender only. The bankruptcy trustee might also want it. A bankruptcy exemption must cover all home equity to prevent losing it to the Chapter 7 trustee.

Bankruptcy exemption laws allow filers to keep property needed to maintain a home and employment after bankruptcy. Most states offer a homestead exemption to protect a particular amount of home equity, and a few states protect the entire home, regardless of its worth.

The problem arises when a filer can't protect all the home's equity with a homestead or wildcard exemption. In that situation, the Chapter 7 trustee sells the house for the benefit of creditors. The trustee uses the proceeds to pay all mortgages and HELOCs in full (the lien requires this), returns the homestead or wildcard exemption amount to the filer, and pays sales costs and the trustee's fee. The trustee distributes whatever remains to unsecured creditors.

Example. Lucy protected $100,000 of home equity using her state's homestead exemption when she filed for Chapter 7 bankruptcy. However, her home value exceeded the mortgage and HELOC by $200,000, giving her $100,000 more equity than she could exempt. The Chapter 7 trustee sold the home, gave Lucy $100,000, paid the mortgage and HELOC in full, and used the remaining funds to pay her outstanding child support arrearages and credit card debt.

Learn how to keep a house in Chapter 7 bankruptcy.

HELOCs in Chapter 13 Bankruptcy

Chapter 13 bankruptcy is for filers who have enough income to repay some or all of what they owe using a three- to five-year repayment plan. A significant benefit of Chapter 13 is that filers can use the payment plan to bring overdue mortgages and HELOC payments current over time, allowing them to save their homes. In rare cases, filers can remove or "strip" HELOC liens and pay less than what's owed.

Curing HELOC and Mortgage Arrearages in Chapter 13

The Chapter 13 plan lets you prevent foreclosure by curing a HELOC or mortgage arrearage over three to five years. You must prove that you earn enough to make the monthly HELOC payments, cure the arrearage through the plan, and pay other amounts required by Chapter 13. The bankruptcy court won't approve or "confirm" your plan if you can't meet these requirements.

Example. Suppose you are $3,600 behind on your HELOC payments when you file Chapter 13. You'll pay $100 monthly through a 36-month plan, plus trustee fees and other required amounts. At the end of the plan, you will be current on the HELOC, free of most other debts, and not at risk of losing your home.

Calculating a Chapter 13 plan payment is complicated. Consider using a Chapter 13 payment calculator to estimate your monthly plan payments.

Stripping a HELOC in Chapter 13

If the market value of your home is less than you owe, you might be able to "strip" or remove the HELOC or another junior mortgage lien. The rule is that you can remove a lien for a junior mortgage or HELOC if, after selling the home, not even a dollar would be available to pay on the mortgage or HELOC to be stripped.

When a mortgage or HELOC qualifies for lien stripping, the filer isn't required to pay the regular monthly payment plus arrearages to keep the home. Instead, the plan pays the HELOC with other debts in the lowest payment category.

This approach is less expensive because these nonpriority, unsecured debts—like credit card balances, medical bills, and personal loans—must share the filer's disposable income, which could be as low as a few dollars. The bankruptcy discharge order erases the remaining balance of most of these debts after plan completion, with the main exception being student loans. This valuable benefit is available in Chapter 13 only—not Chapter 7.

Example. Suppose you owe $300,000 on a first mortgage, $49,500 on a second, $25,000 on a third, and $10,000 on a HELOC, and that a home sale would bring $400,000. In Chapter 13, you could strip the HELOC only. The mortgages wouldn't qualify for lien stripping because the home sale proceeds would fully pay the first and second, and $500 would be available for the third.

Example. Assume the same facts as above except that a home sale would bring $250,000. In that case, the second, third, and HELOC could be stripped because the sales proceeds would not be enough to pay the first fully.

Learn more about removing mortgages in Chapter 13 bankruptcy.

Other Chapter 13 Requirements for Saving a Home

A Chapter 13 plan is usually quite expensive, and it's not uncommon for people who'd like to use Chapter 13 to lack the income required to keep a home using this chapter—and people with large amounts of home equity often face the most significant Chapter 13 hurdles.

Because Chapter 13 filers don't lose property, they must be able to afford to pay for any nonexempt equity—equity not covered by a bankruptcy exemption—in the plan.

Example. Assume a filer with $120,000 in nonexempt home equity faced foreclosure. The filer would need to be able to pay $2,000 monthly to cover the equity alone to save the home using Chapter 13. This amount would be in addition to the monthly mortgage and HELOC payments, household expenses, the trustee's fee of up to 10%, and other Chapter 13 plan payment requirements.

Learn what you must do to keep a home in bankruptcy.

How to Report Property in Bankruptcy

All bankruptcy filers must list everything they own on Schedule A/B: Your Property. They'll list the property they can protect or "exempt" on another form, Schedule C: The Property You Claim as Exempt.

Exempt property typically includes those things needed to maintain employment and a household. The protection doesn't extend to unnecessary luxury "nonexempt" items. What happens to nonexempt property depends on the bankruptcy chapter filed.

A Chapter 7 bankruptcy trustee sells nonexempt property and distributes the proceeds to creditors. Chapter 13 trustees don't sell property. Instead, Chapter 13 filers pay creditors to keep the nonexempt property through the three- to five-year plan.

How to Report a HELOC in Bankruptcy

When you complete your bankruptcy schedules, you'll report your debts in one of two categories. Debts such as HELOCs and mortgages involving property liens are "secured debts."

When listing these debts, the filer will tell the court which property listed in Schedule A/B: Property secures the debt. Debts not involving liens, like credit card balances and medical bills, are "unsecured debts" and aren't linked to any property owned by the filer.

The two categories provide the court, trustee, and creditors with important information about the debts the trustee must pay. For example, a trustee's primary job is finding funds to pay unsecured debts, not secured ones, because a secured creditor doesn't need the trustee's help. It has the exclusive right to recover and sell the collateral—for instance, the house securing the HELOC or mortgage—to pay its debt.

That's not to say a Chapter 7 trustee won't sell secured property—the trustee will, but only in a particular case. The property must be worth enough that after selling it, the trustee can fully pay the secured creditor and have additional money remaining to pay unsecured creditors. In Chapter 13, the filer would keep the house but pay creditors the same amount they would have received had the trustee sold the house in Chapter 7.

Examples of secured debts. This category includes mortgages, auto loans, and HELOCs. Other common secured debts include jewelry, electronics, and furniture credit lines. Secured loans allow the lender to recover the property if you don't pay.

You'll report secured debts on Schedule D: Creditors Who Have Claims Secured by Property.

Examples of unsecured debts. Most major credit cards, department store cards, and gas cards are unsecured debts. The creditor can't recover the property you purchased if you don't pay. Instead, the creditor must go to court and win a money judgment that the creditor can use to garnish your wages, take money from bank accounts, or seize and sell property.

You'll report unsecured debts on Schedule E/F: Creditors Who Have Unsecured Claims.

When to Consult a Bankruptcy Lawyer

If you're like most filers, your home is the most valuable property you own. Unless the home has no equity and you're ready to return it to the bank, it's crucial to be sure you can meet all requirements for keeping it in the bankruptcy chapter you choose.

If you file for Chapter 7, this step is critical because you won't have an automatic right to dismiss the case if you learn the Chapter 7 trustee plans to sell your home. The bankruptcy judge must review your request to dismiss the case and will deny it if moving forward would be in the best interests of your creditors.

In Chapter 13, the concerns are different because you can dismiss the case if you don't want to proceed. However, drafting a Chapter 13 plan the bankruptcy court will confirm can be challenging and you'll likely need to handle more debts through the plan than your home. A bankruptcy lawyer can quickly review your financial situation and explain your options in Chapters 7 and 13, and many offer a free initial consultation.