Protecting present home equity is a sensible focus when considering bankruptcy. Protecting future potential equity can be even more important.
Our last blog posts discussed how to protect the equity currently in your home through the homestead exemption. We discussed property exemptions in bankruptcy in general, and federal and state homestead exemptions in particular. Overall we showed how your homestead exemption can preserve the equity you presently have through a Chapter 7 case.
We mentioned that you can also protect your future home equity through these same tools, but we didn’t describe how. This is worth more attention.
Future Home Equity
Chapter 7 bankruptcy fixates on the present. It deals with debts you have at the moment your lawyer files the Chapter 7 case at the bankruptcy court. In particular, Chapter 7 usually is not interested in new assets you acquire after the date of filing, For example, the money you earn when you go to work the day after filing is outside bankruptcy jurisdiction. Again, for most purposes bankruptcy looks only at what you own on the date of filing.
This is also true as far as your home is concerned. Chapter 7 fixates on how much equity you have in the home at the moment of filing. That is, we look at what the home is worth then, and how much debt there is against it. (The debt includes all valid security interests against the home: mortgages, property taxes, income tax liens, etc.)
But those factors that determine your home equity—the home’s value, and the amount(s) you owe against it—change. They change all the time. The home’s value goes up and down (but mostly up) with the market. The debt on the security interests change every day with interest and every time you make a payment. Generally after filing bankruptcy and getting your financial house in order, you’d make progress paying down home debts. With the home value usually going up and debt against it going down in the years after filing bankruptcy, most people build equity in their home.
Future Home Equity Greater than Present Homestead Exemption Amount
There’s a good chance that at some point—if you keep your home long enough—the amount of your home’s equity will exceed the applicable homestead exemption.
Take this example. A home is worth $300,000, the mortgage is $260,000, with a remaining equity being the difference, $40,000. Assume the applicable homestead exemption is $50,000. That covers the $40,000 in equity.
Now let’s say that in 3 years the home value increases to $335,000, and the mortgage is paid down to $250,000. The amount of equity at that point is the difference: $85,000. That’s $35,000 more than the applicable $50,000 homestead exemption (assuming that hasn’t been increased in the meantime).
If this homeowner filed a Chapter 7 bankruptcy now, the $40,000 in present equity is protected by the homestead exemption. But what if the homeowner doesn’t file bankruptcy now but waits 3 years to do so? The home equity will at that point have increased well beyond the amount the homestead exemption would protect.
Future Equity is Even More Important than Protecting Your Home Now
Sure, when you’re considering bankruptcy, your focus is on the present. As far as protecting your home equity, mostly all you want to hear from your bankruptcy lawyer is that the equity is covered now. Is the home equity going to be protected?
But as you think about whether you should file bankruptcy, Chapter 7 or Chapter 13, and when to do so, potential future equity is arguably an even more important consideration.
Most directly, there are simply likely more dollars at stake in future equity vs. present equity. In the above example, the person was protecting $35,000 in home equity when filing bankruptcy now. But by the same bankruptcy filing he or she was protecting $85,000 in future equity. Isn’t protecting that future $85,000 at least as important in protecting the present $35,000 in value?
When you consider whether to file bankruptcy, you’re thinking about both the present and the future. You want relief and a fresh start now so that you can have a more financially peaceful and prosperous future. When thinking about your home, Chapter 7 allows you to preserve your present modest equity now so that it’ll have the opportunity to build it into much larger future equity.