In bankruptcy, property appraisals can be crucial. Under chapter 7, a proper valuation can mean the difference between keeping and losing the property. Under chapter 13 it can significantly impact the amount you will have to pay to unsecured creditors.
I wanted to mention this in the blog because I’ve noticed an uptick in bankruptcy filers with at least some equity in their homes. Of course equity is normally a good thing, but it can be a real problem when you're trying to wipe-out debts in bankruptcy.
WHAT IS EQUITY?
The term “equity” can mean different things. For the purposes of our Chicago bankruptcy discussion EQUITY is the value of an ownership interest in property – whether personal property or real property. The most common property that comes into play in bankruptcy are houses and cars.
Here’s how to figure out the equity in your property:
FIRST, take the difference between the market value of the property and the balance on the loan you made to purchase the property (this is also the lien value). If you've paid off your loan and there is no lien, you have 100% equity in the property. Or, put another way, the property is owned by you “free and clear.”
SECOND, account for co-owners. In most cases, property is either owned by only one person or by two people who are married. If you are the sole title holder, all the equity in the property belongs to you. If, on the other hand, you share title with someone else, that equity is divided like the ownership interests (usually 50/50).
Here's an example
If your house has a market value of $100,000 and you still have a $70,000 mortgage to pay back, the value of your ownership interest (your equity) is $30,000 (the difference between the market value and the balance on the loan). It’s only $30,000 and not the full $100,000 because if you were to ever sell the home, you can only keep what you don’t have to pay back to the bank.
If someone else owns the property with you, the $30,000 in equity is divided according to each person’s ownership interest. In the case of joint tenants, the equity would be divided 50/50 with each owner getting $15,000 each.
FYI: This works the same way with personal property too (cars, motorcycles, etc.)
In cases where the balance on the loan is more than the market value of the property, your ownership interest is not worth anything and you have no equity. It’s worth zilch because after a sale at market value, you wouldn’t have anything left for yourself after paying the lender. In fact, you would owe the lender money (a deficiency). This is when your interest in the property is considered “upside-down" or "underwater.”
SO: When you have equity, you have an interest in property that is worth money. When you don’t have equity, you still have an interest in property, but it’s not worth any money.
ROLE OF EQUITY IN BANKRUPTCY
Equity essentially dictates whether or not you will be able to keep the property or how much you will have to pay back to your unsecured creditors.
Here's How it Works
The law generally only allows you to keep only a certain portion of the equity. The remainder is distributed among your creditors. The size of the equity portion you can keep depends on property type and locality of the filing. Locality matters because different states have different rules for dividing equity between the owners and creditors. These rules are called “exemptions.”
Bankruptcy and Property with No Equity.
When you have no equity there is no value to share. The lender you’re making payments to has first dibs on the entire value of the property. Generally, you will not lose that property in bankruptcy as long as you continue making payments as agreed. Remember, the most common reason people lose property in bankruptcy is because they have equity in it unsecured creditors can share.
In a Chapter 7 bankruptcy, if you don't have property with equity, the dischargeable debts are wiped out without unsecured creditors getting a dime. You just get on with your financial fresh start.
Bankruptcy and Property with Equity.
When you have equity there IS, or more appropriately MAY be, something to divide between you and the creditors. As stated above, the division is made according to certain rules. These rules specify the amount of equity each owner can keep. Any equity that exceeds the owner's share must be divided among the creditors.
Keep in mind that the only way the equity can be divided is if it’s turned into cash. And the only way to turn the property into cash is to sell it (“liquidate” it). The exceptions are if you can come up with the money to payoff the chapter 7 trustee (the trustee liquidates the property and disburses the proceeds to creditors), or pay the equity to the creditors over time through a chapter 13 reorganization plan.
EQUITY WILL REBOUND WITH THE HOUSING MARKET
While the jury is still out, the consensus seems to point to a strong rebound in the housing market. “The housing market is rebounding faster than anyone thought possible...” says Blackstone Group LP (BX)’s global head of real estate Jonathan Gray. (check out this article in Bloomberg.com . As home prices increase, owners who were only marginally upside-down will start to see positive equity. If the rebound continues, equity may exceed the share you can protect. This is especially true if you are the sole title holder.
Consequently, if you're a home owner and considering bankruptcy to wipe out your debts under chapter 7, or haven’t yet decided if you want to strip that second mortgage or otherwise reorganize your debts using chapter 13, your time to do so may be slowly running out.
In chapter 7, the property may have to be sold. In chapter 13, equity causes problems in two ways: For one, you can only strip a second mortgage if it's completely unsecured. This means that you can't have any equity in the property. And two, you have to pay your unsecured creditors at least the value of the equity they would receive if the property was liquidated under chapter 7 bankruptcy. This is known as the "liquidation test." This may mean that you will have to pay more to unsecured creditors than your budget can afford, preventing you from proposing a plan a judge will approve.
AND...BACK TO APPRAISALS
I hope by now you realize the importance of appraisals in bankruptcy as the housing market continues to rebound. As prices increase, bankruptcy trustees and creditors will start scrutinizing the value of your home. Both parties will be on the lookout for equity that exceeds your allowed exemptions.
An appraisal by an expert can be invaluable because it is the most objective assessment of the property’s value. Providing an appraised value in the bankruptcy forms will lessen this scrutiny and will be greatly appreciated by the bankruptcy trustee who would otherwise have to dedicate more time and resources into obtaining an appraisal herself. The risk of losing the property justifies the extra expense of an expert appraisal. And it's best to have all the details and issues of the bankruptcy case worked out before the case is even filed so there are no surprises.
So, if you are unsure of the market value of your home, it behooves you to find out before the bankruptcy process is initiated. Where there is a chance of unprotected equity, it behooves you to fork out the $300 for a full appraisal.
IN SUMMARY
Equity is the difference between the market value of the property and the loan balance. The equity is divided among ownership interests in the property. State laws allow each owner to keep a certain share of the equity. Generally, in bankruptcy, the equity exceeding the owner’s share must be divided among creditors. I’m seeing an uptick in circumstances where the property is no longer underwater where the owner is unsure about the amount of equity in the home. If you’re considering a fresh start and own a home, spending the $300 for a proper appraisal can be priceless.
So, keep this in mind. FIRST, if your attorney does not raise the issue and simply accepts the market valuation you got from Zillow, consider consulting with a different bankruptcy attorney. SECOND, if you're a homeowner and you’ve been contemplating wiping out your debts or stripping that second mortgage through bankruptcy but weren’t sure whether to file, your time for a no-asset case may be running out as the housing market continues to rebound.
- BKguy
“Get out of debt . . . and start living your life in color.”
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