Dealing with Creditors When Your Home Equity is Larger than Your Homestead Exemption
March 1, 2010 by Oliveros & O'Brien, P.C.
The last two week’s blogs introduced the Oregon "homestead exemption" and then showed how it works in practice. We described some situations in which this exemption gives only limited protection. This week we show you how we can help you deal effectively with even these situations with the help of the bankruptcy law.
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The downward slide in real estate values has left most homeowners with less equity in their homes and many owing more than their homes are worth. Those who still do have some equity, usually have less than the amount of the homestead exemption: in Oregon, $50,000 for a married couple, $40,000 for a single person.
In spite of this overall loss in equity, just about every day we still talk with homeowners who have more equity in their homes than the homestead exemption. They have either paid off their mortgage through a lifetime of payments, or have paid it way down and have not refinanced to tap the equity. Or some of our clients received their home through an inheritance or as a gift from a parent.
If you are a homeowner with more equity in your home than the $50,000/$40,000 homestead exemption, then you have some major challenges in dealing with your creditors. Your home is an easy target for all your creditors, not just the ones related to your home (like your mortgage). If you owe on medical bills or credit cards, one of those creditors could take your home away from you. If that creditor demanded payment and you could not pay it, it could get a judgment against you, put a lien on the house, and in many circumstances could foreclose on that lien.
Many homeowners in this situation believe that bankruptcy is not an option. They think that if they have a home with equity which is more than the homestead exemption they will lose it if they file a bankruptcy. That is often not the case. In many situations a good attorney can help you save your home or use its equity much more favorably through wise use of the tools that the bankruptcy laws provide. The rest of this blog explains how this works.
Protecting a Home NOT Fully Protected by the Homestead Exemption
Last week we gave this example of a single person—we’ll call her Laurie—whose homestead exemption DOES NOT protect her home from foreclosure by a creditor with a judgment against her, because the amount of equity in the home is more than her $40,000 homestead exemption:
House value: $280,000
minus mortgage: - 195,000
equals equity: 85,000
minus homestead:- 40,000
equals $45,000 available to pay judgment
Let’s say the creditor is a collection company with a $10,000 judgment against Laurie on a medical debt. Let’s also say that Laurie owes another $60,000 in other medical bills and credit cards (her “general unsecured debts”).
If Laurie is not able to pay this $10,000 judgment, the creditor could foreclose on her home to get it paid. Often at the foreclosure sale the highest bid is only enough to pay the minimum required: the amount of the mortgage and the judgment debt, the homestead exemption, and the sheriff’s and the creditor’s costs and fees. In this case, Laurie would get her exempt amount—the $40,000. But she would still owe $60,000 to her general unsecured creditors. If she paid the $40,000 she received from the house sale to those remaining creditors, she would still be $20,000 short ($60,000 debt minus $40,000). And she would have no home.
The Chapter 7 Option
If she files a Chapter 7 bankruptcy case, almost for sure the bankruptcy trustee would take her home from her and sell it, because it has equity well beyond her homestead exemption. From the proceeds of the sale (after paying the costs of sale like the realtor’s commission, escrow and title fees, plus the court-approved trustee fees), the trustee would first pay the $10,000 judgment lien to the collection company, and then the $40,000 homestead exemption to Laurie. The trustee would divide any remaining sale proceeds among Laurie’s remaining $60,000 of “general unsecured” creditors. In the end she would have no home, but she would have $40,000 in her pocket and would OWE NOTHING to anybody. This is much better than having received no money from the house after paying the other creditors, and still owing them $20,000, as would likely happen if she did not file a Chapter 7 case.
The Chapter 13 Option
Or Laurie could file a Chapter 13 case, and potentially KEEP HER HOUSE and OWE NOTHING to any of her creditors at the end her three-to-five year Chapter 13 plan. She would have that three-to-five year period to pay the creditors the amount of money they would have received had she filed a Chapter 7 case.
What that means is that we would estimate how much the house would have sold for had a Chapter 7 trustee sold it. Then we would calculate who would have received money from the sale, and how much. Assuming the house would have sold for its fair market value of $280,000, we would subtract the $195,000 mortgage, the $10,000 judgment, the $40,000 homestead exemption, and what the costs of the sale and the Chapter 7 trustee’s fee would have been. Here’s the calculation:
House value: $280,000
minus mortgage: -195,000
minus judgment: -10,000
minus homestead exemption: - 40,000
minus cost of sale (approx. 7%) -19,600
minus trustee’s fee (a legal formula):- 4,250
equals $11,150
This $11,150 is the amount which theoretically would have been available to a Chapter 7 trustee to pay to general unsecured creditors. So in a Chapter 13 case, Laurie would have to pay $11,150 of the $60,000 that she owes to those creditors (maybe more, if her budget enabled her to pay more), in addition to paying off the $10,000 judgment lien on her home. But she would be given as much as 5 years to do so. If she has the budget to do this, she would keep her home and pay her creditors tens of thousands of dollars less than without a bankruptcy.
In the meantime, the collection company with the judgment would not be allowed to foreclose on its lien (as long as Laurie made payments as approved in her Chapter 13 plan). And her “general unsecured” creditors would not be able to chase her either. At the end of her case, she would have her home and would owe nothing to anybody.
Conclusion
At Oliveros & O’Brien we will be happy to review your own homestead situation in a free consultation. To schedule this consultation, please call us at 503-786-3800 or click on “Contact Us” above. We look forward to using our expertise to find the best solution for you and your home.