Question: I think I really screwed up. I owe almost as much as I earn on my credit cards, and before the pandemic, I took out a home equity loan. I thought I could handle it all, then the shutdown happened. My wife is out of work entirely and I had to take a furlough. I haven’t paid on that home equity loan, and I’m getting nasty letters.
We’re thinking about bankruptcy, and from what I can tell, that’s no problem for the credit cards. But what about the home equity loan? I keep hearing how bankruptcy lets you keep your house, but is that true even if I can’t pay back the home equity loan? The Internet is a wonderful thing, but it doesn’t give me a clear answer on this. I don’t know why.
– Paul in Georgia
Steve Rhode, The Get Out of Debt Guy, replies…
The reason the Internet isn’t giving you “a clear answer” is simple: There isn’t an easy one. But I can tell you the general rule…
Home equity loans are liens, and if you don’t pay, you can’t stay.
A less satisfying but more thorough answer is: It depends. On what? Where you live, for one thing. Bankruptcy and other debt protections are administered by the states – and you live in one of the worst for that, Paul.
The National Consumer Law Center ranks each state on how well it protects its residents against debt collectors. Six states got F grades last year:
- Delaware
- Georgia
- Kentucky
- Michigan
- New Jersey
- Utah
Another factor is where you got your home equity loan in the first place. Some lenders are more forgiving than others. They’ll patiently work with you on a repayment plan. Others will want to seize your house as soon as they legally can, so they can resell it.
What is a home equity loan, anyway?
Before we go any further, let’s review what happened when you took out that home equity loan. For something that sounds so simple, it can get a little confusing.
The most important word in “home equity loan” is equity. Simply put, equity is the difference between what your home is worth and what you owe on your mortgage. You build up equity in two ways, one you can control and one you can’t. Make those monthly payments and maybe add a little bit, and you build up equity. Another way: The real estate values in your area go up.
When you take out a home equity loan, you receive a lump sum of cash that you pay back at a relatively low-interest rate (at least compared to those credit cards Paul is struggling with). But here’s the problem: The collateral for that loan is your home itself.
A home equity loan creates a lien against your house. Liens are legal obligations you make, allowing a creditor to seize the assets you put up as collateral. So, if you don’t pay back that home equity loan, you can easily lose your house.
It gets worse: If you want to sell your home while you still have that loan, you must pay off the entire balance first.
What bankruptcy can and can’t do
In bankruptcy, you seek legal relief from our creditors. Basically, the lender’s legal protections (liens) face off against your legal protections (bankruptcy). Here’s where it starts getting complicated.
While the federal government sets the procedures and boundaries of bankruptcy, states get a lot of leeway to make their own rules. They can decide what assets you can protect from creditors. It can get very weird.
In Wyoming, if you owe less than $5,000 on your car, you can often keep it. Not so in Alabama, though. In Ohio, you can protect one burial plot, but in New Hampshire, you can protect up to six sheep.
Even the simplest of bankruptcies are confusing. Adding a home equity loan on top of that isn’t something Google can settle for you.
Now what?
The best way to look at a situation involving both real estate and lenders is to concede you’ll never figure out all the rules and regulations by yourself. Thankfully, you still have options.
Whenever debts and liens on a property exceed its value, it’s critical to seek legal advice from a bankruptcy attorney who’s licensed in your state. That raises the question, “How do I find a good attorney?”
While you can learn all about that here, my advice is to look for an attorney after you consult a credit counselor. Why? Because you want to contact an attorney with a good grasp of your situation. Getting a free debt analysis might point you to other solutions. Will your lender negotiate with you? Can a debt management program lower your credit card payments enough to cover your monthly payments on that home equity loan? Is debt settlement right for some of your debts?
Even if the answer ends up being bankruptcy, you’ll go into it with your eyes open. There’s no easy way out when a home equity loan can’t be paid back, but the good news is: There are people out there who will do their best to help you.
