Why Owing More May Help You In Bankruptcy

This may seem counter-intuitive, but owing more on your home mortgage can actually be a godsend in wither a Chapter 7 or Chapter 13 bankruptcy.  In a Chapter 7 bankruptcy, the Chapter 7 trustee is an individual appointed by the U.S. Trustee to administer your case.  This is a fancy way of saying this person is in charge of selling your non-exempt assets so he or she can distribute some funds to your unsecured creditors (medical bills, credit cards, etc.).  You see, immediately upon filing your petition, all your property is now property of the newly created bankruptcy estate, except of course for the property you can exempt under Georgia state law.  Exempt property is a dollar amount that you can shield from the grasp of creditors.  For instance, in Georgia, an individual can exempt up to $21,500 in his homestead.  This means that if the trustee were to sell your home for the benefit of your unsecured creditors, you would receive $21,500, if that much equity existed in your property.
So how does owing more to your mortgage lender help you? Because liens survive bankruptcy, and the mortgage lender is deemed to have a lien equal to the amount that you owe.  For example, if you own a house that is worth $200,000 but only owe $100,000 to your mortgage lender, you will have $100,000 in equity.  Because the trustee of the bankruptcy estate is now the new owner of this equity, he or she may sell it to recover the $100,000 to be distributed to your creditors.  In reality, out of the $100,000, you would receive $21,500, and your creditors would receive whatever is left over after costs of sale and the trustee’s administrative fees are tacked on.  If you were to owe $195,000 to your mortage lender, the trustee would not be interested in selling your home since the equity and amount owed to the lender would eat into all the sales proceeds.
In a Chapter 13, you would propose a plan to pay back your creditors over a 3 to 5 year period.  One caveat is that you must pay back your creditors at least as much as they would receive if you had filed a Chapter 7.  Using the above example, if you were to have $100,000 in equity in you home, you would have to pay back at least $70,000 ($100,000 minus $21,500 exemption minus administrative costs) to your unsecured creditors over a 5 year period.  If you did not have any equity in your home, you could get by with only paying back a fraction of that to your creditors.
Posted by Atlanta Bankruptcy Attorney Will B. Geer.