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Posted by: National Bankruptcy Forum
Last updated Oct. 30, 2017.
Homestead exemption laws prevent the sale of a borrower’s home by their creditors in satisfaction of a debt. In many states, whether your home may be subject to forced sale is a function of how much home equity you have.
A Homestead is Your Primary Residence
A homestead is defined as your primary residence; investment property does not fall within the definition. The purpose of homestead exemptions are rooted in public policy. Home ownership is at the cornerstone of the American way of life, which is why legislatures have made it difficult for creditors to take your home away from you in satisfaction of a debt.
In order for a creditor to force the sale of your primary residence, they must have a judgment against you and your home must have equity. Just how much equity leaves a home vulnerable is a function of state law.
Equity Below Your State’s Homestead Exemption = No Sale
If the equity in your home is below the amount your state exempts, the trustee will not sell your home.
For example, if you owe $25,000 to a credit card lender who has sued and obtained a judgment against you, that company cannot force the sale of your home as long as all of your home equity is exempt under your state’s exemption limit. If you live in state X, whose homestead exemption allows for $50,000 in equity to be protected from creditors and your home is worth $300,000 with a $280,000 mortgage balance, creditors cannot take your home. Your $20,000 of home equity falls below the $50,000 state X allows its residents to protect.
Florida is one state that has historically had an unlimited homestead exemption, which never allowed a creditor to take a home in satisfaction of a debt — regardless of the home’s value, though there is acreage limitation and a length of ownership requirement.
Other unlimited homestead exemption states, with small exceptions, include Texas, Iowa, Kansas, South Dakota, and Oklahoma, in addition to the District of Columbia. Some other states have fairly generous homestead exemptions, including Nevada ($550,000 equity), Minnesota ($390,000 to $975,000, if a farm), and Montana ($250,000). On the other hand, some states have no homestead exemption, like New Jersey and Pennsylvania, though they exempt some form of tenancies.
Equity Above Your State’s Homestead Exemption = Possibility of Sale
If a homestead’s value exceeds the limits imposed by state law, creditors may sell the home but the debtor will be entitled to the amount of their state’s exemption.
Confused? Let’s illustrate the point with an example.
If your home in state X has a mortgage balance of $200,000 and is worth $300,000, you have $100,000 of home equity. This number exposes $50,000 of equity as “non-exempt” because state X only allows $50,000 of equity to be protected. In this example, creditors could force the sale of the home to go after the $50,000. However, were the home to be sold, you would be entitled to a check for $50,000 (the amount of state X’s homestead exemption). A creditor sale doesn’t destroy the exemption.
When there is only a small amount of non-exempt equity, it is unlikely that a creditor will go through with listing the property because the costs of putting the home on the market outweigh the proceeds gained from the sale. In these cases, it is often possible to negotiate a cash settlement with the creditor, which avoids the headaches of a sale.
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