The Two-Home Trap: Why Chapter 7 Isn’t an Option When You Want to Keep Both Houses

If you own more than one property (such as a primary residence and a rental or vacation home) and are considering bankruptcy, you will likely face liquidation of your second home.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

The Common Bankruptcy Mistake

In my conversations with clients, I am often told by the client, “I want to file Chapter 7.” I always follow that statement up with a question of my own: “Did you consult with a prior bankruptcy lawyer who confirmed you qualify?”

Most of the time, the response is “No, but they read online that they don’t have to pay anything back if they file Chapter 7, and that’s what they want.” Unfortunately, that’s not the way it works.

The allure of Chapter 7 is understandable: a fresh start, often with wiping out most unsecured debt like credit cards and personal loans. Not paying anything back sounds like the perfect solution to overwhelming financial stress, but not with this set of facts.

A seemingly simple fact can often slam the door shut on a smooth Chapter 7 filing: owning more than one piece of real estate.

If you own a homestead where you live and another property, be it a rental home, a vacation cabin, or a second investment property, and your primary goal is to keep both of them, Chapter 7 bankruptcy is almost certainly out of the question.

The Problem: Your Second Home is “Non-Exempt”

Chapter 7 is a liquidation bankruptcy. The law is designed to allow the bankruptcy Trustee to take and sell any property that is not exempt under your state’s laws, using the proceeds to pay your creditors.

While nearly every state has a homestead exemption to protect some or all of the equity in your primary residence, that exemption does not apply to a second home, rental property, or investment real estate. Depending on your state’s exemption, even a burial plot is considered real estate and might not be protected. The same applies to timeshares.

• Your Primary Home: Protected (up to your state’s exemption limit).
• Your Second Home: Non-Exempt Equity.

If you file Chapter 7, the Trustee will look at your second property, see that there is non-exempt equity, and will likely sell that property to pay off a portion of your debts. If your goal is to keep that second piece of real estate, Chapter 7 isn’t possible.

The Solution: Chapter 13 Bankruptcy

This is where Chapter 13, the “reorganization” or “wage earner’s” bankruptcy, steps in.

Chapter 13 works differently: There is no liquidation of assets unless you voluntarily surrender the non-exempt assets. Instead of selling your property, you propose a 3-to-5-year repayment plan to your creditors.

If you own two homes and want to keep both, Chapter 13 is the path you must take. In a Chapter 13 plan, you can:

1. Keep Both Homes: You keep all your property, regardless of its value or exemption status.
2. Pay Creditors the “Liquidation Value”: You must structure your repayment plan so that your unsecured creditors receive at least as much as they would have received in a Chapter 7 liquidation. This is known as the liquidation test, and you can read about that here.
3.  Since the second home would have been sold in a Chapter 7, your plan must include paying your unsecured creditors a total amount equal to the non-exempt equity in that second home. For example, if your second home has $50,000 in equity, then you will pay back $50,000 into the bankruptcy plan.

The Chapter 7 Exception (If You Are Willing to Compromise)

The only way a two-home owner can successfully file Chapter 7 and keep their primary residence is if they are willing to voluntarily surrender the non-homestead property to the mortgage lender.

If you are ready to let go of the second home, and:

1. Your primary residence equity is protected by your state’s homestead exemption, and
2. You qualify under the means test. The means test is based on the average of your income over the last six months and compared to the state’s average income.

The Takeaway

If your financial relief strategy relies on keeping both your primary home and a second property, focus your attention on Chapter 13 from the start. Don’t spend valuable time pursuing Chapter 7 only to be disappointed by the liquidation risk. A qualified bankruptcy attorney can analyze your property’s equity and create the  Chapter 13 plan to achieve your goal of keeping your assets while getting the debt relief you need.

Quick Guide to the Basics: Liquidation, Exemptions, and The Means Test

In closing, note that Chapter 13 is extremely complex and should not be considered without a qualified bankruptcy attorney. Studies show that less than five percent of self-represented parties in a Chapter 13 are successful. This is because navigating the rules of the repayment plan, meeting filing deadlines, and responding to Trustee and creditor objections are nearly impossible without an experienced bankruptcy attorney.

Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Paralegals and students who are buying single copies can do so via Amazon Books. To access my YouTube channel, click this link. You can also listen to my podcast on Spotify.

You can learn more about filing for bankruptcy and the bankruptcy petition via this link. Information on the bankruptcy court system, contact information for trustees, and your state’s exemptions can be found here. The federal bankruptcy exemptions are listed here. The latest version of the 341 Meeting of the Creditors can be found here.

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Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.