Bankruptcy filing is possible even if you have equity in your house. However, if you cannot protect it through exemption, you might end up losing it. There are various factors that determine what will happen to the equity. These include the bankruptcy chapter, the duration of ownership, and the state of federal exemption you are using.
Both Chapter 7 and chapter 13 allow you to exempt certain equity in your home. However, the non-exempt equity is treated differently in both these chapters. In Chapter 7 bankruptcy, any non-exempt property is handed over to the bankruptcy trustee to be liquidated. The trustee can sell your home to pay mortgages, liens, and taxes, pay you the exemption amount, take their commission, and pay the remaining amount to the creditors. If enough money is not generated to cover all these expenses, the bankruptcy trustee might not sell the property. If you would like to keep your house with nonexempt equity, you can opt for a chapter 13 bankruptcy. In this case, you need to pay the creditors an amount equivalent to the non-exempt amount through your 3- to 5-year repayment plan.
Limit of equity you can protect
Since bankruptcy is supposed to provide a fresh financial start, some property is exempted. While state law defines the type and amount of property you can exempt, some states also offer bankruptcy filers a choice between state or federal exemptions. Usually, exemption for equity in homestead is available under state law. If you own any other real estate property, to protect it, you will require specific exemptions under state of federal law.
To avail any state bankruptcy exemption, you need to have resided in the state for more than 2 years. If you have moved recently, you need to use homestead exemption allowed by the state where you resided for 180 days before the two years period. People who have owned a homestead for less than 40 months before bankruptcy filing, can get a $170,350 exemption irrespective of the exemption scheme. This limitation is to prevent people from taking advantage of the generous homestead exemption offered by a few states.