Thoughts about bankruptcy come during moments of despair and overwhelming pressure, and for many, the main worry is, “Will I lose my home?” Quite often, we can happily say that a debtor can keep a home, but like many complex situations, it depends. What happens to a house depends on interconnected factors: the equity in the home above and beyond exemptions, the homeowner’s ability to make the required payments, and the amount of debt on the house.
Equity and Exemptions.
It is expected that everyone is to pay their debts, and, in general terms, if they have excessive property, it can be used to pay off their debt. Exemptions protect certain property from creditors when filing Chapter 7 and they are used to determine how much a debtor pays creditors throughout a Chapter 13 plan.
In Pennsylvania, an owner has a choice to use two types of exemptions to protect the home. The first option is the Federal Exemption which can protect up to $23,675.00 in equity in the home. The second is the Pennsylvania tenants by entirety (“T&E”) exemption. There is no limit to the T&E exemption which can be generous, if an owner has $1 million in equity, the home is still protected. But, there is one caveat, a debtor cannot have any joint unsecured debt with their spouse for the exemption to be effective.
The homeowner’s ability to make the required payments.
Filing for bankruptcy won’t erase mortgage debt, but it eliminates other debts to free up money to cover secured debts such as a first mortgage. Chapter 13 reorganizes debts, and, with a court approved plan, a debtor can pay back creditors over a period of up to five years. At the end of the term of the plan, any remaining unsecured debts are discharged (except domestic support obligations and student loans), leaving the debtor responsible for only secured debts such as a home mortgage. This is ideal for people who can afford to maintain possessions like a home, but need some financial relief in order to repay other debts including past unpaid mortgage payments.
The amount of debt on the house.
In the case of Chapter 7 bankruptcy, the process of mortgage foreclosures is halted, buying time for the homeowner. If a debtor feels confident that mortgage payments will be made once unsecured debts are discharged, Chapter 7 could be beneficial and gives a debtor time to enter into a reaffirmation agreement with the mortgage lender.
In some Chapter 13 cases, an unsecured second mortgage on a home can be reduced if the value of the house is less than the payoff of the first mortgage. In bankruptcy terms, this is called a “cram down.” If the situation allows, a debtor can eliminate second mortgages. Provided that the first mortgage has not matured, it typically cannot be crammed down, but loans on other property are eligible, which can free up monies to pay back a primary mortgage. Cramming down loans can also reduce interest rates and stretch payments over longer periods of time in order to lower monthly costs.
Bankruptcy is designed as a fresh start, not to leave a debtor impoverished. We tell our clients that, in general, bankruptcy trustees are not interested in a debtor’s home. If there is no equity over and above the exemption claimed, the trustee won’t attempt to sell the house to pay the creditors.
For more information about rights and options of homeowners considering bankruptcy, please contact our office.