You may be able to keep your home and preserve most or all of the equity in it by using the homestead exemption in a Chapter 7 or Chapter 13 bankruptcy. If the homestead exemption covers all of your equity, you can prevent the trustee from selling your home in a Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, you will keep your home because you will be paying your debts through a repayment plan, and you can exempt at least some of your equity. If you have more equity in your home than what the exemption protects, you will need to include an amount equal to the additional equity in your repayment plan.
The amount of the homestead exemption depends on the state where you live. It may even be unlimited in some states, although it is more likely to be limited. A few states do not have a homestead exemption, in which case you may want to use the federal exemptions if they are an option. The federal bankruptcy exemptions include their own homestead exemption. Many states allow you to choose which set of exemptions to use, although you cannot choose the homestead exemption from one set while using the other exemptions from the other set.
Homes with Non-Exempt Equity
Only primary residences may qualify for the homestead exemption. Second homes, vacation homes, or investment properties will not be protected.
In some situations, you may have more equity in your home than the homestead exemption covers. Under Chapter 7, the bankruptcy trustee will need to sell any non-exempt property. This includes a home that has non-exempt equity in it. The trustee will sell the home and pay the mortgage holder, since this is a secured creditor that takes priority. Afterwards, the trustee will reimburse the debtor for the amount of the homestead exemption and distribute any remaining funds from the sale to pay unsecured debts.
Under Chapter 13, by contrast, your monthly payments under the repayment plan will include the non-exempt equity in your home. If this amount is substantial, your monthly payments may be very high. This can create challenges for debtors who do not have substantial income. They may not be able to meet the monthly payments in the required period of three to five years. If the bankruptcy trustee feels that this may be a concern, they may file an objection to the proposed repayment plan. The court will hold a hearing to determine whether to confirm the plan. If the court rejects the plan, the debtor may need to sell the home, pay off some of their debts, and then file for bankruptcy.
Domicile Requirement for Homestead Exemptions
Federal law imposes a domicile requirement on debtors who are trying to apply the homestead exemption. To use the full amount of the exemption, they need to have purchased the residence for which they are claiming the exemption at least 40 months before filing for bankruptcy. However, if you owned a previous home in the same state and used the proceeds of selling it to buy your current home, you can apply the time that you lived in the first home to meet this requirement. The purpose of the requirement is to prevent a debtor from moving to a new state with an unlimited exemption and buying a home there shortly before filing for bankruptcy so that they can take advantage of the unlimited exemption.
Homes owned for less than 40 months are subject to an exemption cap.
You can still use some of the homestead exemption if you do not meet the 40-month requirement. Federal law imposes a certain cap that changes periodically, regardless of whether a state allows a higher exemption amount. The same cap applies to debtors who have committed crimes such as bankruptcy fraud in the past.