Ask Brian: Should a Homeowner File for Bankruptcy if They Have Equity in their Home?
Ask Brian is a weekly column by real estate expert Brian Kline. If you have any questions about real estate investing, DIY, buying / selling homes, or other housing inquiries, please send your questions to firstname.lastname@example.org.
Question from Michael to AL: Hello Brian, I have experienced several years of financial problems. Even before the pandemic, I had health issues that prevented me from working full time, which led to financial problems as early as the summer of 2019. In a sense, closures and uncertainty related to the pandemic have all aggravated. In other ways, the pandemic helped a bit because I was able to take advantage of financial assistance that became available, including the mortgage forbearance program which put mortgage payments on hold. I’m not actually on a forbearance program but I’m about three months behind on my payments. I had some security knowing that the forbearance program was there as a safety net if I wasted even more time in my payments. Now that security is fading. There seems to be a lot of uncertainty as to when exactly the forbearance programs will end, but I know it’s coming. I think bankruptcy might be my only option. What is important for me to know about filing for bankruptcy as a landlord?
Answer: Hello Michel. I sympathize with you. The course of bankruptcy depends heavily on personal circumstances. You definitely want to talk to a bankruptcy lawyer before you make a final decision or take action. If you have equity in your home, your state’s home ownership exemption and your financial situation will determine if bankruptcy is a good idea. I guess you want to get out of bankruptcy by still owning your home. However, keeping your house in bankruptcy is not easy. The huge increase in home values means most people have more equity in their home than they probably realize. Too much equity can make your home a target for the bankruptcy trustee to sell to pay off creditors. Michael, you didn’t say if you have any other debts that would be part of bankruptcy, but it is also part of what you need to consider in your situation. Bankruptcy can slow down a mortgage foreclosure, but it could be just another temporary solution.
You want to strike up a conversation with an attorney to understand the differences between Chapter 7 and Chapter 13 bankruptcies as well as the role a homestead exemption can play. There is a federal homestead provision, but most people follow their state’s homestead laws. In a Chapter 7 bankruptcy, the bankruptcy trustee has the power to sell your non-exempt assets (including your home, depending on the homestead arrangement) to pay off your creditors. In a Chapter 13 bankruptcy, you must pay the value of your non-exempt assets to your unsecured creditors through your repayment plan. In a nutshell, Chapter 7 requires that a lot of your assets be sold to settle debts. Chapter 13 allows you to keep the assets, but you will need to comply with a court-ordered and closely watched payment plan.
However, Chapter 7 does not mean that your house will automatically be sold to pay off creditors. Whether or not this happens is determined primarily by the equity you own in the home and your state’s homestead laws. Remember, you are not the person making these calculations and determinations. The court and the trustee have the last word. (Michael, Alabama, your homestead is worth up to $ 16,450 in equity and up to 160 acres of real estate and the residence therein, including a house, mobile home, or similar accommodation. Code Ala. 6-10-2.)
I can’t stress enough the importance of working with a bankruptcy lawyer, but here is the basic formula for determining if you have enough equity in the home to force a sale to pay off your creditors.
- Determine the current fair market value of the house.
- From the fair market value, you subtract the homestead exemption.
- Then subtract the trustee’s commission which is on a sliding scale based on the value of the property.
- Subtract the remaining mortgage balance because the lender needs to be paid off.
- Subtract the cost of selling the house as this money will not be available to pay off debts (usually 8% of fair market value).
- Finally, subtract all other liens currently guaranteed by the house (such as tax and mechanical liens).
A negative number on the end result works in your favor because it means you don’t have enough equity to pay off debt. There is no reason for the trustee to sell the house. If the result is a positive number, you should receive payment for the homestead exemption, but the rest of the money will go to paying creditors.
However, speak to your lender before or at the same time as you speak to a bankruptcy lawyer. I don’t know how many, but there are certainly a lot of people coming out of the pandemic and facing similar circumstances. Your lender may still be willing to discuss a “mortgage repair” with you. This could mean renegotiating your payment terms with a loan modification or refinancing. Of course, if you can’t make the mortgage payments, you will end up losing your home to foreclosure outside of bankruptcy, even if the bankruptcy trustee doesn’t sell your home.
Michael, there are other things a lawyer can help with in bankruptcy, such as possibly keeping a car through a reaffirmation agreement with the lender.
Your thoughts on foreclosures and bankruptcy? Please comment.
Our weekly Ask Brian column welcomes questions from readers of all levels of experience with residential real estate. Please email your questions or inquiries to email@example.com.
Author Biography: Brian Kline has been investing in real estate for over 35 years and has been writing about real estate investing for 12 years. He also draws on more than 30 years of business experience, including 12 years as a director at Boeing Aircraft Company. Brian currently lives in Lake Cushman, Washington. A vacation destination, close to a national and the Pacific Ocean.