Will Having Lots of Home Equity Affect My Chapter 13 Bankruptcy?

If you have significant equity in your house that is not exempt in bankruptcy, it could increase your Chapter 13 plan payment.

By , Attorney · University of the Pacific McGeorge School of Law

One of the differences between Chapter 7 and 13 bankruptcy is that you can keep all of your property in Chapter 13. But there's a catch. Filers often have to pay creditors a portion of the asset's value, and doing so can get expensive fast. To understand how this works, you'll need to know about the following:

  • protecting property using bankruptcy exemptions
  • paying creditors in Chapter 7 and 13
  • the "best interest of creditors" test, and
  • how to calculate a Chapter 13 plan.

Keeping Property—Including Home Equity—Using Bankruptcy Exemptions

You don't lose everything when you file for bankruptcy, but you don't choose what you can protect, either. Instead, you'll start by reviewing your state's bankruptcy exemption laws. They'll help you determine how much property you can keep. The exemptions protect the same amount of property regardless of whether you file for Chapter 7 or 13 (read "Paying Creditors for Home Equity in Chapters 7 and 13" below).

Most states have a homestead exemption that will cover some equity in your house, or, if your state law allows you to choose between state and federal exemptions, you might opt for the federal bankruptcy exemptions. Homestead amounts vary significantly between states, and if yours is among the more modest, check for a wildcard exemption. You might be able to stack it on the homestead exemption and protect additional equity. Any equity you can't protect with a bankruptcy exemption is "nonexempt," and creditors will be entitled to receive an equivalent amount of funds.

Example. Pranav's state allows him to keep $50,000 of equity in a residential home using a homestead exemption. His house has $80,000 of residential equity, so if he files for bankruptcy, the first $50,000 will be exempt and protected from Pranav's creditors. His creditors will be entitled to receive $30,000—the nonexempt equity amount.

Paying Creditors for Home Equity in Chapters 7 and 13

Your creditors will receive the value of any nonexempt property that you can't cover with a bankruptcy exemption—even if you file for Chapter 13. Although creditors receive an equal amount in both Chapters 7 and 13, creditors get paid differently. Here's how it works.

Chapter 7 is designed to give low- or no-income filers debt relief. Because these filers don't have sufficient income to repay creditors, the Chapter 7 trustee sells nonexempt property and distributes the proceeds. By contrast, Chapter 13 helps those who can afford to pay some amount to creditors. Instead of selling property, the Chapter 13 trustee collects the value of the nonexempt property through the repayment plan and distributes the funds to creditors. In essence, a Chapter 13 debtor must pay to keep nonexempt property.

Example. Pranav has $50,000 of exempt equity and $30,000 worth of nonexempt equity in his home. If he files for Chapter 7, the trustee will sell Pranav's house, give him $50,000, and distribute the remaining $30,000 to his creditors (minus sales costs and trustee fees—find out how the trustee gets paid). If Pranav files for Chapter 13, Pranav will have to pay at least $30,000 to creditors through his Chapter 13 plan (likely significantly more—read how to calculate the Chapter 13 repayment plan below).

"Best Interest of Creditors" Test Can Increase a Chapter 13 Payment

The rule that requires a Chapter 13 debtor to pay an amount equal to any nonexempt equity is known as the "best interest of creditors" test. Not only does it ensure that creditors get the same amount regardless of the chapter filed, but it's why having a lot of equity in your home will increase your plan payment significantly.

Example. Michael owns a home worth $400,000. He has a mortgage with a $125,000 balance giving Michael $275,000 of equity. The homestead exemption in Michael's state allows him to exempt $100,000 of his home equity, leaving Michael with $175,000 in nonexempt home equity. If Michael has no other nonexempt assets, he must pay unsecured creditors at least $175,000 through his repayment plan minus costs (he'll pay less if he doesn't owe unsecured creditors that much, of course). Assuming a five-year plan, Michael must earn enough to cover $2,917 per month, plus any other required plan amounts.

Learn what happens to unsecured debt in Chapter 13 bankruptcy.

Calculating the Chapter 13 Repayment Plan

Figuring out whether you can keep your home in Chapter 13 bankruptcy isn't easy. Why? Because you must calculate your entire repayment plan first—and the amount you must pay certain creditors can add up fast. Start by deducting monthly living expenses from your income. With the remaining amount, you'll need to cover:

  • monthly mortgage and car payments unless you plan to give the collateral property (the house or car) back to the lender
  • the full amount of any missed mortgage, car loan, or other secured debt payments (if you want to keep the property)
  • the total amount of any priority debts you owe, such as support obligations and most taxes
  • the value of your nonexempt property (including your nonexempt home equity), and
  • any other disposable income that remains after paying the above expenses.

Learn more about debts you must pay back in Chapter 13 bankruptcy and how to calculate the Chapter 13 bankruptcy plan payment.

Consult With a Bankruptcy Lawyer

Most attorneys use a software program to calculate a Chapter 13 plan—it's not an easy thing to do otherwise. Consider meeting with a local bankruptcy attorney to learn more about protecting your home in bankruptcy and the steps involved in a Chapter 13 case.

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