Calculating your home equity
Home equity is the difference between what your home is worth and what you owe on it. In bankruptcy, the calculation includes costs of sale because the trustee can only recover what is left after selling expenses.
- Fair market value (FMV) -- what a willing buyer would pay today. Zillow estimates, recent comparable sales, or a formal appraisal can establish this.
- Minus all liens -- first mortgage, second mortgage, HELOC, tax liens, judgment liens, HOA liens
- Minus costs of sale -- real estate commissions (5-6%), closing costs, transfer taxes. Typically 8-10% of the sale price.
- Equals net equity -- this is what the trustee compares to your homestead exemption
Example calculation:
Home FMV: $300,000
First mortgage: -$230,000
Second mortgage: -$25,000
Costs of sale (~9%): -$27,000
Net equity: $18,000
If your homestead exemption is $25,000 or more, the home is fully protected.
Equity in Chapter 7
In Chapter 7, the trustee evaluates whether selling your home would generate meaningful proceeds for creditors after paying off liens, sale costs, and your exemption. This is called the "liquidation analysis."
If the answer is no -- which it is in most consumer cases -- the trustee will not pursue the home. Even if you have some non-exempt equity, if the amount is small (under $10,000-$15,000), many trustees will conclude it is not worth the effort of a forced sale.
What if I have significant non-exempt equity?
If you have substantial non-exempt equity in Chapter 7, you have several options:
- File Chapter 13 instead -- you keep the house but must pay the non-exempt equity amount to unsecured creditors through your plan
- Negotiate with the trustee -- some trustees will accept a lump-sum payment equal to the non-exempt equity in exchange for abandoning the property
- Let the trustee sell -- you receive your exemption amount from the sale proceeds and any excess goes to creditors
Equity in Chapter 13
In Chapter 13, you keep your house regardless of equity. But the best interests test under 11 U.S.C. § 1325(a)(4) requires that unsecured creditors receive at least as much as they would in a Chapter 7 liquidation.
This means if you have $30,000 in non-exempt equity, your Chapter 13 plan must pay at least $30,000 to unsecured creditors over the plan period. The more non-exempt equity you have, the higher your plan payments.
11 U.S.C. § 1325(a)(4) -- Best interests test: The court shall confirm a plan if "the value, as of the effective date of the plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under chapter 7."
Factors that affect the equity calculation
- Property values are volatile. A home worth $300,000 today might be worth $280,000 or $320,000 in six months. Trustees and courts know this.
- The trustee's valuation may differ from yours. If there is a dispute, the court may order a formal appraisal or hold an evidentiary hearing.
- Judgment liens can reduce equity. Under 11 U.S.C. § 522(f), you may be able to avoid (remove) judicial liens that impair your homestead exemption.
- Tax liens survive bankruptcy. IRS and state tax liens generally pass through bankruptcy and reduce your equity for calculation purposes.
- Underwater homes have zero equity. If you owe more than the home is worth, equity is zero and the trustee has no interest in the property.
Most bankruptcy filers have little or no non-exempt home equity. Between existing mortgages, the costs of sale, and homestead exemptions, the trustee rarely finds enough meat on the bone to justify selling a debtor's primary residence. If you are worried about your equity, consult a bankruptcy attorney who can run the numbers for your specific situation.