One of the only times that having “too much equity” in your home will hurt you is when you are filing for Chapter 7 bankruptcy. It seems contradictory, but having too much equity in your home can seem to turn into a consequence for petitioners hoping to obtain a discharge of debt through Chapter 7 bankruptcy. If you aren’t sure how that’s possible, keep reading and we’ll go through it so you don’t find yourself in a tough situation after you’ve already filed. This is one of the factors of bankruptcy that is most important to consider before you file.
When you file for Chapter 7, you’re looking for a way to wipe out your debt, but you don’t want to lose your house. It doesn’t seem like too much to ask and in most instances, bankruptcy is designed to do exactly that. But you can only protect so much of your home’s equity. The law varies by state, but each designates a cap on the amount of equity you can protect. In California, you can protect from $75,000 to $175,000 in equity. It’s referred to as your “homestead exemption.”
In cases, when you have more equity in your home than is allowed by bankruptcy law, the trustee will ask for the difference. You’ll be asked to turn over cash to cover the amount of equity over the cap. If you can’t, the bankruptcy trustee will sell the home in order to recover those funds. The bankruptcy trustee isn’t being mean to you. It’s simply the law. That’s all there is to it. Here’s an example.
Linda Smooty bought a home when she was 24 with a slightly larger than normal down payment. She’s been making all her payments on time ever since and even trying to make an extra full month’s payment each year to bring the balance down faster. 8 years after she purchased her home, she had a two week mental breakdown during which she had an illicit affair with her married CEO, took out credit at every store she frequented, maxed out every card (old and new), traveled the world on credit and made plans to “run away from it all” with the new love of her life. This involved cashing out (and maxing out) every aspect of her finances not already tapped out to purchase a little place on a lovely island at the guidance of her very charming new love. At the end of the two weeks (which were so fun and so exciting) she was left wondering what happened when the CEO ran off with his wife to the little place she had purchased in his name “for convenience sake.” Linda was left with very few options and even less dollars in her account. When she turned to bankruptcy to solve the financial side of this particularly twisted problem, her home was worth $275,000. She had a balance of $73,000. So in order for her to gain bankruptcy protection with Chapter 7, she will need to be able to make up the difference – providing the bankruptcy trustee with a minimum of $27,000 cash. If she can’t do so, she will lose her home. The trustee will need to sell it to recover those funds.
Linda is just one of many who would find themselves in a situation that would require that they determine which course of action will end up costing her less money. If the trustee sells the house, it will be sold to the highest bidder. Linda (or you, if you are in a similar circumstance) would receive the homestead exemption amount first. The trustee then takes the remaining amount from the sell of the house to pay creditors. After all creditor payments and trustee fees are covered, any remaining funds would go to Linda (or the petitioner at hand).