One of the biggest reasons people are afraid to file for bankruptcy is that they think they're going to lose their home. But did you know that filing a Chapter 13 bankruptcy can actually be one of the most effective ways to protect your home while also getting relief from overwhelming credit card and medical debt?
Let me explain how this works.
Here's something most people do not understand about bankruptcy. Just because you qualify for a Chapter 7 based on your income, that doesn't necessarily mean a Chapter 7 is the best option for you, especially if you have substantial equity in your home.
Qualifying for Chapter 7 Is Only Part of the Analysis
When people come into my office looking for help with their debt, one of the first things we look at is their household income. That's because a Chapter 7 bankruptcy has income eligibility rules. Those rules can be very complicated, but the basic idea is that we're looking at whether your household income and financial circumstances allow you to qualify.
But that's only part of the analysis. Bankruptcy doesn't just care about what you earn. It also cares about what you own, and that's where things can get really interesting.
Let's imagine somebody comes into my office with a modest household income. They're struggling with credit card debt, and maybe they've got medical bills. They're making their mortgage payment every month, but the rest of their financial life is getting harder and harder to manage.
We do the income analysis, and they qualify for a Chapter 7 bankruptcy. That's supposed to be great, right?
Well, maybe. Because then I ask them about their house.
What Home Equity Means
Let's say their house is worth $300,000 and they only owe $100,000 on their mortgage. That means they've got approximately $200,000 in equity.
I want to explain exactly what equity means, because people sometimes confuse it with money they have available to spend in the bank. Equity is essentially the difference between what your property is worth and what you owe on it.
In our example, $300,000 minus $100,000 leaves $200,000 in gross equity. This doesn't mean my clients have $200,000 sitting in a savings account. They might have lived in that house for 25 years. They might have bought it when houses were much less expensive, and they've probably spent decades making mortgage payments.
Suddenly, on paper, they have a valuable asset. They still don't have enough money to pay their credit cards, but they've got a valuable asset.
This situation is not unusual, and it creates problems in a Chapter 7 bankruptcy.
How Home Equity Can Create a Problem in Chapter 7
When you file a Chapter 7 bankruptcy, a bankruptcy trustee is appointed to review your financial circumstances. The trustee then determines whether you have any property that can be administered for the benefit of your creditors.
The law protects certain property through things called exemptions. One of the most important exemptions for homeowners is the homestead exemption. The amount of equity you can protect in your home depends on the law that applies to your case, based on where you live and some of your individual circumstances. These protections can vary dramatically from state to state.
So having $200,000 in equity does not automatically mean you're going to lose your home. It also doesn't automatically mean you would keep it if you filed a Chapter 7.
If there's enough equity that is not protected by exemptions, a Chapter 7 trustee may be able to:
Sell the property
Pay the mortgage and the cost of the sale
Pay you the exemption amount you're entitled to
Send the remaining money to your creditors
I want you to understand something. Getting a check for your homestead exemption is not the same thing as keeping your house.
Now, trustees don't sell every house that has a little bit of unprotected equity. There has to be enough value to make a sale worthwhile after all the applicable costs and protections are taken into account. That's why we actually have to do the math.
Why Chapter 13 Works Differently
Suppose we've done the math and there's substantial equity that could be available to creditors if you filed a Chapter 7 in the state where you live. What do you do?
This is where Chapter 13 bankruptcy can be extraordinarily useful, because it operates very differently. Instead of a Chapter 7 liquidation, an eligible person can propose a repayment plan that will generally last 3 to 5 years.
Here's the principle I really want you to understand. In a Chapter 13 bankruptcy, your unsecured creditors generally have to receive the value they would have gotten if you had filed a Chapter 7. That's the concept behind something called the liquidation test, or the best interest of the creditors test.
This is one of the reasons a Chapter 13 can be such a powerful tool for homeowners.
The Math Behind the Example
Let's go back to our original example. I've got a client who qualifies for a Chapter 7 based on their household income, but they have substantial equity in their home.
Let's imagine that after we account for the mortgage, the applicable exemptions, the cost of a hypothetical sale, and other relevant expenses, we've determined that a Chapter 7 liquidation would produce $30,000 for unsecured creditors.
Instead of putting the house at risk of being sold in a Chapter 7, we can propose a Chapter 13 repayment plan that allows my client to keep their house while also providing the required value to those creditors.
Let's do some very simple math:
$30,000 for unsecured creditors
Divided by 60 months, which is 5 years
That's $500 per month
I want to be very clear here. I'm not telling you this person's total Chapter 13 payment would be $500 a month. There can be trustee fees, attorney fees, other debts that might have to get paid through the plan, and additional legal requirements that might affect the actual payment. The $500 illustrates the value creditors would have received from a hypothetical Chapter 7 liquidation, and what it looks like to pay that over time in a Chapter 13.
This person may have spent decades paying for their home. They might have accumulated a lot of equity, and they've probably got a mortgage payment they can afford. What they cannot afford is all of the unsecured debt that's piled up around them and their house.
A Chapter 13 may give them a way to address that debt without sacrificing the home they've worked so hard to keep. That's a very different outcome from assuming a Chapter 7 must be the right choice because their income qualifies them for it.
Not Everybody Files Chapter 13 for the Same Reason
Here's another thing that surprises a lot of people. I might have one client whose household income is relatively modest, but they have a lot of equity in their home. Their Chapter 13 may be driven primarily by the value of the property they're trying to protect.
On the other hand, I might have a different client who has very little non-exempt property, but whose household income and allowable expenses leave them with disposable income that has to be committed to a Chapter 13 plan.
Those two clients could owe exactly the same amount of credit card debt, but their Chapter 13 payments could look wildly different, because we're solving two different problems. One problem involves the value of the property. The other involves the income available to repay creditors. And sometimes a person has both issues.
Can Chapter 13 Save Every House?
No. I sure wish it were that simple.
A Chapter 13 plan has to be financially feasible. If someone has so much non-exempt equity that the required repayment is more than their household could realistically afford, a Chapter 13 may not actually solve the problem.
That's why it's so important to have somebody look at your entire financial picture before you make a decision about bankruptcy. Your income matters. Your debt matters. Your property matters. And what you want to protect will matter the most.
What I Want You to Take Away
If you're struggling with debt and you own a home, please remember these two things:
Do not assume that bankruptcy automatically means you're going to lose your home.
Do not assume that qualifying for Chapter 7 means Chapter 7 is necessarily your best option.
There may be a way to protect what you've spent years building while getting meaningful relief from the debt that's making your life miserable.
The right chapter depends on how much you owe and how much you earn. It also depends on what you own, what you need to protect, and what you can realistically afford.
Watch the Video and Get Help
I'm Adrienne Hines, a bankruptcy attorney in Northwest Ohio. I take the shame and embarrassment out of the conversation about debt.
Schedule a free consultation with Adrienne (Northern Ohio only).
Call her office at 419-625-7770.
This post is for general educational purposes only and is not legal advice. Bankruptcy laws and exemptions vary by state and by individual circumstances. Reading this post does not create an attorney-client relationship. Talk to a qualified bankruptcy attorney about your specific situation.
