Can a Home Equity Line Be Discharged in Bankruptcy?
A home equity line of credit (HELOC) is different than a home equity loan. Many hear the term “home equity” and erroneously believe that one is another term for the other. A home equity loan is a fixed loan for a specific and unchanging amount of money. A home equity line, on the other hand, is a line of credit that may have a maximum draw, but the money is borrowed on an as-needed basis.
In other words, if you are purchasing a $500,000 home, a HELOC creditor may be willing to advance you up to $500,000 but you aren’t necessarily required to borrow the entire amount at one time as you would with a home equity loan. HELOCs can also be used for other purposes other than repaying mortgage costs. This line of credit is secured as a lien on your home.
Whereas once, HELOCs were used almost exclusively for second mortgages, it is becoming increasingly common to find them being used for first mortgages. Sometimes HELOC is used to refinance first mortgages.
HELOCs have numerous advantages. For those needing to make major home improvements or make serious repairs to a property, HELOCs allow them to draw as much as they need without overdrawing on an expenditure you may not know the cost of upfront. You can use them to pay credit cards or other monthly expenses.
HELOCs have an intrinsic risk of unstable interest rates. Market pressures affecting other areas of real estate can drive up the interest rates of HELOCs considerably. This is how so many people found themselves in trouble during the housing bubble. A HELOC lender has a right to cut a credit line which is what many creditors did as housing values rapidly declined.
Discharging HELOC in Chapter 7
You can discharge your HELOC in Chapter 7 but what you’re actually discharging is your liability to repay the debt. Importantly, HELOCs are secured against the equity in your home making the loans secured and not unsecured. Much like all other secured loans, Chapter 7 discharges your liability to repay the loan but that does not make the property on which you owe the debt owed.
A bit of history. During the housing bubble, many homeowners took out home equity lines of credit (HELOC). Once the bubble burst, they struggled to make payments on their HELOC loans and were unsure if it was even worth given that the value of their home had plummeted. Many lenders cut off HELOC loans which was within their legal right. This left homeowners without a safety net to get them through the most difficult part of the recession. The result was a massive amount of foreclosures related to HELOCs.
This brings us to perhaps your most pressing question: Can a home equity line be discharged in Chapter 7 bankruptcy? The answer yes. Can I keep my home?
Home Equity Loans and Bankruptcy
During the boom, many homeowners took out home equity lines of credit (HELOC) and are now struggling to repay those loans plus their mortgage. Can a debtor discharge their HELOC in Chapter 7 bankruptcy and keep their home? The short answer is no. A debtor can discharge the home equity loan in Chapter 7 bankruptcy but they cannot discharge it AND keep their home.
However, if a debtor would like to keep their home, they may be able to file Chapter 13 bankruptcy and repay both their HELOC and their mortgage over a 3 to 5 year period. If, after completing your Chapter 13 bankruptcy repayment plan, there is a balance on your HELOC loan that may be discharged, effectively reducing the amount you pay out to the lender.
For example, if you had a $100, 000 mortgage with a $20,000 HELOC in Chapter 13 bankruptcy you may end up only paying $12,000 on the HELOC and the balance being discharge in bankruptcy. But remember, in Chapter 13 bankruptcy, you will repay on all of your creditors, including credit cards. Also, your Chapter 13 bankruptcy repayment amount will be determined by your income and ability to pay.
Stripping Off HELOCs in Chapter 13 Bankruptcy
If you HELOC is a second (and not a first mortgage), there are some cases in which you can strip it off in a Chapter 13 bankruptcy.
It’s increasingly unlikely in today’s market, but if the value of your home is less than the amount that you owe on the primary mortgage, the HELOC is not technically secured against anything. If the value of your home is going up or has remained relatively stable, then it’s likely that the lien placed on your home by the HELOC is still secured against the value of the home.
But if it isn’t, it can be considered unsecured debt. You will be required to pay some of it, but, generally, most Chapter 13 filers only end up paying a tiny fraction of the original debt back. Once the Chapter 13 is complete, the remainder of the HELOC debt will be discharged.
However, the process may not be as simple as it sounds. Depending on the court and the judge presiding over the case, they may ask for additional information or require that you file an adversary proceeding in order to strip off the HELOC.
The bottom line is, you will need to prove to the court that the HELOC is no longer secured against the value of your home and will require an appraisal in order to move forward with the process of stripping of the HELOC. In cases where your outstanding debt on your first mortgage is very close to the value of your property, they may require a second appraisal before moving forward. Judges can be prickly about stripping liens off of property when the borrower consented to the lien.
HELOCs and Foreclosure
Let’s say that the property value of your home has not devalued to less than the amount owed on your original mortgage. (Thus you don’t qualify for a strip down.)
HELOCs that are used as second mortgages are subordinated to primary mortgages in the hierarchy of repayment. This is as true when a house is foreclosed on as it is when a debtor files for bankruptcy. If a HELOC lender forces a home into foreclosure, they are risk ever getting repaid at all. They must use that legal tool very carefully. If it is unlikely that they will see a major return by forcing the sale of a home, then they probably won’t force the home into foreclosure.
If they do force the home into foreclosure, you can stop the foreclosure by declaring bankruptcy. In the case of Chapter 13, you can repay the arrearage on your HELOC over the course of a three- or five-year plan.
If Your Income Increases During Your Chapter 13 Bankruptcy
If your income increases during your Chapter 13 bankruptcy that increase must be reported to the bankruptcy trustee and it may impact how much you pay to your creditors. However, in a Chapter 7 bankruptcy, if you have a HELOC you will need to repay it only if you want to keep your home or you can discharge it and your mortgage loan and surrender the home to the lender. It’s important for each debtor to carefully weigh the feasibility of keeping their home. Ask yourself…can I really afford to keep this home?
If you do not earn enough income and attempt to keep your home during bankruptcy, you could possibly face foreclosure after your bankruptcy and end up in a bad financial situation again.
Can a Home Equity Line Be Discharged in Bankruptcy? Ask a Bankruptcy Attorney
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