Usually, when a homeowner finds out that his house has gone up in value beyond his wildest expectations within a few short years, it's good news. But if the homeowner is on the brink of bankruptcy, too much appreciation can be very bad news. Too much equity in a home may eliminate bankruptcy as an option, unless the homeowner is prepared to lose his home in a sale by the bankruptcy trustee.
Home ownership in a bankruptcy context works like this (for those debtors who are current on mortgage payments):
- If the debtor has little or no equity in his house, but is current on payments, then he'll usually keep the house in a chapter 7 bankruptcy (chapter 7 is the typical kind of consumer bankruptcy case which takes a few months to complete). The trustee's job is to liquidate any assets with significant equity to pay creditors, so the trustee has no interest in real estate with no equity.
- If the debtor has substantial equity in his house, if he files under chapter 7, the trustee will be obligated to sell the house to pay the debtor's creditors. In this situation, the debtor will usually file for bankruptcy under chapter 13 (a consumer reorganization case), and make payments to his creditors over a period of 3 to 5 years (not 100% of what they're owed usually, but some percentage determined by several factors, including how much the debtor earns in income). The idea behind this is that the debtor is paying his creditors what they would receive in payments if the case were filed under chapter 7 and the house were sold.
- What happens when a debtor has substantial equity in a house, but doesn't have sufficient income to make payments under a chapter 13 payment plan? He may decide to simply sell the house on his own, use the equity to pay creditors, and then, if significant debts still remain, file under chapter 7.
In recent years, due to the crazed real estate market, many more people have found themselves in this bind. Good luck in the real estate market can translate into very bad luck if you fall upon hard times and have to contemplate filing for bankruptcy.