Updated May 20, 2016
If you have equity in your home (meaning your home is worth more than what you owe on it), the homestead exemption may allow you to keep it if you file for Chapter 7 bankruptcy. The homestead exemption comes into play in Chapter 13 bankruptcy as well. It determines, in part, how much you must pay to your unsecured creditors. The homestead exemption only applies to your residence -- you cannot use it for other properties. (For more information on exemptions, see our Bankruptcy Exemptions area.)
Read on to learn how the homestead exemption works in bankruptcy.
The equity in your home is considered an asset in your Chapter 7 bankruptcy and the trustee can take your house and sell it if you can’t exempt that equity. This is where the homestead exemption comes to the rescue. In Chapter 13 bankruptcy, if you have lots of nonexempt equity in your home, you'll end up paying a bundle to your unsecured creditors. So a generous homestead exemption can mean the difference between being able to fund a Chapter 13 plan or not.
Here’s an example of how the homestead exemptions works.
Let’s say your house is worth $500,000 but you still have a mortgage balance of $400,000. This means that your equity (or value to the bankruptcy trustee) in your home is $100,000. If your state has a homestead exemption greater than $100,000, then you have nothing to worry about. You can use that exemption to keep the bankruptcy trustee from being able to sell your house to pay your creditors. However, if your state’s homestead exemption is only $50,000, then the trustee will likely sell your house and use the money to pay your creditors.
Keep in mind that the trustee still has to pay you the amount that you were able to exempt. So in the above example, you would receive $50,000 and the remaining $50,000 would be distributed among your creditors and used to pay the costs of sale and the trustee’s fee.
The homestead exemption is different for each state and the federal system. If your state allows you to use the federal bankruptcy exemptions, you can currently exempt $23,675 (or $47,350 if you are married and jointly filing bankruptcy) under the federal homestead exemption. However, if you don’t live in a state that allows you to use the federal exemptions, you must use your state’s homestead exemption if it has one. In that case, whether you can keep your home will depend on the amount of your state’s exemption amount. Some states allow you an unlimited or a very high homestead exemption but a few states don’t even have one at all.
To find the homestead exemption amount in your state, determine whether you can use the federal bankruptcy exemptions, and learn about other details specific to your state, see the articles in our Homestead Exemption in Your State area.
In an attempt to prevent people from moving to and buying a house in a state with an unlimited homestead exemption in order to shield their assets from bankruptcy, federal law places certain restrictions on the homestead exemption. In order to take advantage of a state’s homestead exemption, you must have bought and owned your home there for at least 40 months prior to the bankruptcy (if you sold your home and bought a new one in that same state with the sale proceeds then the time you owned your first home will still count toward the 40 month requirement). If you cannot satisfy this requirement, then federal law caps your homestead exemption at $160,375 regardless of your state exemption amount.
Your homestead exemption is also capped at $160, 375 by federal law if you have committed bankruptcy fraud or certain other crimes.