How do I protect my home in a bankruptcy?
NOTE: Please consult the Washington Center for Real Estate Research for information pertaining to median home values by county. Median values change quarterly, thus the median prices quoted below will have changed by the time you read this post. That said, they’re still useful for understanding homestead exemptionss.
TLDR: The Homestead Exemption applies to filers who own a home in Washington state and who wishes to protect their home equity. Notice that the thing being exempted is the equity and not the home itself. The reason for this has to do with public policy favoring the average homeowner.
Today we’re going to talk about one of the most important and powerful exemptions in bankruptcy law: the homestead exemption. First, let’s add a few wrinkles.
Federal v. State: there are two types of homestead exemptions—because of course there are. The state exemption in Washington depends upon which county you live in.
To qualify for the full state exemption amount: you must have owned the property (or an interest in it) for at least 1215 days prior to the date you file your petition.
If you’ve owned your home for less than 1215 days, you are limited to $125,000 of exempt equity. There are a few moving parts here, such as whether you sold a previously home in order to purchase your current home.
There’s a different between Net Equity and Gross Equity. Let’s discuss that next.
Gross v. Net Equity + How to deal with exposed equity
In bankruptcy, there is both gross equity and net equity. First, take the current market value of your home. Zillow is a potential tool for this, but a written offer to purchase is king. Second, subtract the amount owed on the mortgage. This gives you the gross equity. If you own your home outright, the market value is your gross equity.
So, if your home in Spokane County is worth $500,000.00, and your remaining mortgage owed is $350,000.00, then your gross equity is $150,000.00.
Now let’s suppose your house is worth $400,000.00, and your mortgage is paid off. We’re still in Spokane County. You gross equity is literally $400,000.00. This means you’ve got exposed equity because the exemption amount for a home in Spokane County (as of this writing) is $350,000.00*. Does this now mean that a Chapter 7 bankruptcy trustee will sell your home and hand you a check for $350,000.00? Maybe. Maybe not. Keep reading. (For the current median prices by country, see Washington Center for Real Estate Research.)
It’s important to think like a trustee on this topic. A trustee is not a magician (at least not professionally), nor can they instantly liquidate your assets with the wave of a hand. Like everyone else in real life, the trustee would have to sell your home, which means there needs to be buyers willing to pay what the trustee thinks your home is worth. In some cases, you might want to pay a real estate appraiser to ascertain the market value of your home.
Now let’s discuss Net Equity.
First, you can determine you net equity by subtracting the Washington state homestead exemption for Spokane County from the market value of your home. Second, subtract any relevant costs of sale like a realtor’s fee, closing costs, and (yes) taxes. The remainder is net equity for the purposes of bankruptcy.
Thus, assuming the trustee’s realtor charges a 6% commission on a $400,000.00 home (not a given), that’s $24,000.00 that can no longer be paid to creditors. Then you have the Real Estate Excise Tax (REET), which is 0.5% ($2,000.00) in this example. Now we’re up to $26,000.00 in money that won’t be going to creditors, and $24,000.00 that will go to creditors. But wait, the trustee will get a cut of that amount, assuming they can sell the house, leaving the creditors with potentially less than $22,000. In this instance, a trustee may well find it worthwhile to liquidate your house.
Let’s try another scenario. Suppose your home in Spokane County has a market value of $400,000.00, but you owe $40,000.00 on it. You now have $10,000.00 of exposed equity. Assume the trustee: hires a realtor, sells the house, pays the taxes, pays the mortgage, and then cuts you a check, there could about $375,000.00 in proceeds remaining. (This also assumes, of course, that the house has no obvious issues that might prevent or delay a sale.) Of this, $40,000.00 will go to paying the mortgage, leaving $335,000.00. Then the trustee will need to cut your a check for the exempt equity ($350,000.00), leaving -$15,000.00 for the trustee to pay to your creditors. In other words, it’s a losing proposition and the trustee would be doing all this work for free.
So, put your bankruptcy trustee cap back on. Are you really going to liquidate someone’s home if none of the proceeds end up going towards paying creditors? How much different would it be if, let’s say, the trustees is able to use the proceeds to pay only a small percentage of your outstanding debt? Is it really a worthwhile endeavor for the trustee? When does it become worthwhile? The answers, as with many things involving the law, is it depends. Yes, it depends upon your specific situation, which is why it’s always a good idea to get professional legal advice when filing for bankruptcy protection.
The upshot to all this is that if you want to save your home during bankruptcy, you want a lawyer to guide you through the particulars of your situation.
