Portland Bankruptcy Law Group

If you file a bankruptcy as an Oregon resident, the homestead exemption protects the first $40,000 of equity in your home, $50,000 if you’re married and both of you are on the deed to the property.  With the slide in home values of the last several years, most people thinking about bankruptcy don’t have more equity than these amounts.  Many have no equity at all, and so they may think they are not helped by the homestead exemption at all.  But this exemption is more flexible and powerful than you might think, as the following examples show.

1. Broad definition of “homestead” creates opportunities:

The homestead exemption covers a lot more than equity in the conventional stand-alone house.  If you have an ownership interest in and are living in a manufactured home, whether or not you own the land it sits on, and whether or not it is permanently attached to the land, any equity you have in that home (up to the same $40,000/$50,000 limits) is exempt.  That also applies to a floating home or houseboat, as well as a mobile home, again as long as actually living in it when your bankruptcy case is filed.  In fact you don’t even need to be living there as long as it’s the home of your spouse, or “dependent child” or “dependent parent.”

This exemption may apply even after you’ve sold your homestead: the proceeds of that sale are protected by the homestead exemption as long as your intent is to use those proceeds to acquire another homestead, and in fact you do so within one year.

Even if you own NO real estate at all, but have paid in advance on a residential lease, your “leasehold interest” is also protected.  So is any money you’ve paid in advance on a month-to-month rental—first and last month’s rent and any refundable deposits.

2.  Judgment lien avoidance:

If there’s a judgment against you, that judgment very likely creates a lien against your real estate. Liens usually have to be paid eventually, and may give the holder of the lien the power to foreclose on your real estate in order to force you to pay.  If that real estate is your home, AND if the amount of equity in that real estate (before accounting for the judgment lien) is no more than the applicable $40,000/$50,000 limit, then either a Chapter 7 or Chapter 13 bankruptcy will likely enable you to “void” that judgment lien—take it permanently off the home’s title.

Overall, what’s important is that with the continued slide in market values in most neighborhoods of Portland and the surrounding areas, the protection provided by the homestead exemption has effectively expanded.  Homes that may not have been fully covered by the exemption may well now be covered, and judgment liens that could not have been fully avoided may now be avoidable.

In our last blog we talked about how reduced home values can be an advantage if you file a bankruptcy case.  We showed how lower values can help you keep your home if you file a Chapter 7 case, and how it can reduce what you have to pay to your unsecured creditors in a Chapter 13 case.  Today we talk about taking advantage of lower home values through judgment lien avoidance in either Chapter 7 or 13, and “stripping” second mortgages in Chapter 13.

Judgment Lien Avoidance

If you have been struggling financially for a while, a creditor may have sued you and then gotten a judgment against you.  Most of the time, that judgment would be a lien against your home.  In fact, probably one of the main reasons a creditor would go through the expense of suing you would be to get that judgment lien, as a way of pressuring you to pay the debt.  That’s because in many situations a judgment lien gives the creditor the right to seize and sell your home to pay off the debt secured by that lien.

Bankruptcy—either Chapter 7 or 13—provides a way to get rid of judgment liens, but only if the amount of equity you have in your home (before accounting for the judgment lien) is LESS than the homestead exemption.  Basically, you get to preserve equity up to the amount of your homestead exemption ($40,000 for a single person, $50,000 for a married couple), and to “avoid” any judgment lien which “impairs” (eats into) the applicable homestead exemption.  If you have equity in your home (again, before accounting for the judgment lien) which is larger than the homestead exemption, then you would not be able to “avoid” the judgment lien, or not all of it, depending on the amount of the judgment and the amount of your equity.

So, if your home has fallen in value leaving equity that is no more than the homestead exemption amount, you will now be able to “avoid” the entire judgment lien, whereas you would not have been able to earlier. You would be able to write off the debt and have no judgment lien against your house after your bankruptcy is finished.

“Stripping” Second Mortgages in Chapter 13

If you file a Chapter 13 case and your second mortgage is completely under water (your first mortgage balance plus unpaid property taxes is larger than the value of the home), we can “strip off” the lien securing this mortgage against your house.  This turns this secured debt into an unsecured one.  Then during the three-to-five years that your Chapter 13 case takes to run its course, you pay relatively little on this now unsecured debt (or sometimes even pay nothing). Assuming you finish your case successfully, whatever is left unpaid on that debt at the end of your case is completely written off.  And if you kept your house and maintained your other obligations on it, that second mortgage and its lien against the title will be gone forever as well.

When you took out that second mortgage, your home was very likely worth enough to cover that second mortgage.  The reduction in your home’s value is what caused your second mortgage to be completely under water, thereby allowing this lien “stripping.”

In our last blog we talked about how the home values have fallen during this Great Recession.  Particularly, we showed how, both nationally and in the Portland area, prices recovered somewhat during portions of 2009 and 2010 but have been again decreasing and, particularly in Portland in the last couple of months, at a steep rate.

There is a silver lining to this continuing bad news, if you are considering filing bankruptcy.  Reduced, and still reducing, home values have many consequences in a bankruptcy case, and mostly positive ones.  Here are two of the most important ones.  In our next blog, we’ll give you a few more.

1. Keeping your home through a Chapter 7 case: Although most people who own a home and are being forced to consider bankruptcy have no equity in their homes, some still do have equity.  If you file a Chapter 7 case and have too much equity in your home—in Oregon, more than $40,000 for a single person and more than $50,000 for a couple—then you could risk losing that home to your creditors.  But with the ongoing downward slide in values, homes that just a year or two were worth too much, now may well no longer be.

Another twist of this: Although for bankruptcy purposes your home’s property value is determined as of the day your case is filed, the general downward direction in home prices means that if your home value is close to the edge—maybe a bit more equity than the permitted homestead exemption—the Chapter 7 trustee is going to be less inclined to be interested in your house.  That’s because by the time the property would actually be sold, it will likely be worth less, and perhaps less than your homestead exemption.  The trustee generally cannot sell your house if, after paying you the homestead exemption, there would be no money left for your unsecured creditors.

But careful: when eventually the prices DO start going up, the opposite happens—the trustee will be MORE inclined to go after real estate that is on the edge of having equity beyond the homestead exemption.

2. Paying less or even nothing to your unsecured creditors in a Chapter 13 case: In a Chapter 13 payment Plan, one significant factor determining how much you must pay to your unsecured creditors is the amount of equity in all your assets—including your home—beyond the applicable exemptions.  One major reason people file Chapter 13 instead of Chapter 7 is to protect such “non-exempt assets.”  A reduction in home value means that you may well be permitted to pay your unsecured creditors that much less.

For example, if a year ago you and your spouse owned a home then worth $250,000, with a mortgage of $180,000, that home had a gross equity of $70,000.  That is $20,000 more than your $50,000 homestead exemption, meaning that you would have to pay at least that much to your unsecured creditors in your Chapter 13 Plan.  But if the home’s value fell by the average Portland rate of 7.8%, your home would now be worth about $19,500 less, or about $230,500.  Let’s assume that the debt did not go down at all (if you miss just one payment or make a few payments late, the extra fees and/or interest will usually more than make up for any of the slow progress on the principal balance).  That means that the home would be only $500 over the homestead exemption instead of $20,000 over— the current home value of $230,500 minus $180,000 debt = $50,500 in equity, minus $50,000 exemption = $500.  All other things being equal, that Chapter 13 plan would cost you about $20,000 less to pay off.

Please visit us in two weeks for our next blog on more advantages of lower home values in bankruptcy.  We’ll talk about judgment lien avoidance and “stripping” second mortgages.