Chapter 7 Bankruptcy: What You Need To Know About The Homestead Exemption
With chapter 7 bankruptcies, a trustee will cancel all your debts, but this doesn't mean you can keep your assets. To pay off these debts, the trustee will normally liquidate your assets, but legal exemptions may allow you to keep your home based on the available equity. Find out how these exemptions works, and learn more about what you need to do to hold on to this equity.
How the homestead exemption works
When you are considering a chapter 7 bankruptcy, you need to consider the different outcomes that are possible. To clear spiralling debts, most homeowners worry that a chapter 7 bankruptcy means that they will have to lose their home, but this isn't always the case.
The chapter 7 homestead exemption exists to help homeowners keep their properties after a bankruptcy ruling. The exemption applies only to your main residence, so you cannot apply this rule to investment properties. The amount that you can claim exemption against depends on the equity you hold in your home.
To calculate the equity in your property, take the total market value and deduct the amount of outstanding mortgages or other liens. If the remaining equity falls below the exemption limit where you live, the bankruptcy trustees cannot take your house. If the equity is more than the exemption limit, the trustees will normally take the house and sell it, leaving you with a cash payment for the exempt amount.
Federal versus state limits
The government normally reviews federal homestead exemption limits every three years ending on April 1. These changes reflect shifts in the Consumer Price Index. In 2014, the federal exemption limit was $155,675. The exemption law for homesteads includes real property, mobile homes and burial plots.
Some states don't allow you to use the federal homestead exemption and will impose a state-based limit instead. Actual homestead exemptions vary considerably from one state to another.
In some states you can:
- Exempt all of your home equity, whatever the value
- Claim the homestead limit twice for a married couple
- Claim only the state limit
- Choose between the state and federal limit
It's important to consult an experienced bankruptcy attorney for further advice. He or she can help you understand how to get the highest homestead exemption limit possible.
Federal law restricts homestead exemption based on where you have lived before filing for bankruptcy. This condition prevents people selling and then buying property to avoid lower exemption limits. To claim the exemption limit, you must have bought, owned and lived in the property for at least forty months before you file for bankruptcy. If you don't meet this rule, the law will cap the exemption amount you can claim.
This rule doesn't apply if you have bought and sold property in the same state because the same exemption limit would apply to both properties. As such, the law allows you to combine ownership periods to meet the forty month rule. If you aren't able to use the state limit because you haven't lived there long enough, you can normally use the federal limit.
The law also caps the homestead exemption limit if you have committed certain crimes. A bankruptcy attorney can advise you further.
It's important to check the local requirements for a homestead declaration. A homestead declaration is a legal document that you file with your county recorder to prove your home is your principal place of residence. In some states, you must file this declaration before you can claim the exemption limit, while others automatically allow you to proceed without this document.
The dangers of a second mortgage
To deal with their debts, some homeowners decide to take out a second mortgage. This step can significantly increase the risk you will lose your home. If you take out a second mortgage to pay off unsecured debt, you will release equity from your home. As such, when bankruptcy trustees calculate the equity in your home, they will deduct two mortgages, increasing the likelihood that you will lose your home.
If you live in a state with a generous homestead exemption limit, it is often wise to file for bankruptcy if you have a lot of equity in your home.
Homestead exemption limits can allow you to keep your home if you file for chapter 7 bankruptcy. Carefully consider your options, and review the state and federal limits available to you to make the most of the equity in your home.