Many clients who contact my office to discuss their financial options are under the mistaken impression that if they file a bankruptcy they will have to give up their house. In fact, California law provides substantial protection for homeowners and it is quite possible to file a bankruptcy with little or no effect on home ownership.

California, along with several other states, provides substantial exemptions to homeowners who file bankruptcies. An "exemption" is a specific dollar amount which a bankruptcy filer is allowed to keep even though he has filed to discharge his debts.

Exemptions are offered based on a philosophy that people should be able to get out of financial difficulty without losing the roof over their heads or the clothes off their backs. They should be given a "fresh start."

In California, an individual may exempt $50,000 of the equity in his home. A married couple or a single parent with dependents may exempt $75,000. An exemption of $125,000 is available if either spouse is 65 or older, if a single person is at least 55 and has a gross annual income of no more than $15,000 (or no more than $20,000 for a married couple), or if a person is mentally or physically disabled to such an extent that he is unable to work.

An example might make this clearer. Suppose a widowed mother is raising two children in a house worth $200,000 and Happy Lender Bank has a first deed of trust on the house in the amount of $125,000 (leaving $75,000 in equity). The widow was laid off from her job for several months and now is an a position where she cannot catch up with her credit card bills and still manage to pay all her other monthly expenses. The bankruptcy laws allow that woman to file for bankruptcy protection, be relieved of her dischargeable debts, and still retain her house by claiming the $75,000 exemption to which she is entitled.

Of course this does not mean that the regular monthly payments are not due on the house or that back-due mortgage payments can be discharged. The filer must keep these payments current because secured debts, such as Happy Lender's first deed of trust, are not dischargeable.

A variety of other exemptions are available which protect, among other things, some equity in a car, normal household furnishings and clothing, some tools, and retirement accounts.

Currently, each state is allowed to set its own home exemption amounts. Because of this, there have been several strange cases which are being widely criticized. For instance in Florida the equity in a home may be exempted 100% no matter how much the value of that equity is. This has led to several well publicized cases in which wealthy businessmen have exempted millions of dollars in equity in their homes while discharging equally large amounts of debts.

There is some discussion now in Congress of establishing a single national standard for the residence exemption. Critics of that policy point out that such a standard would be unworkable given the huge variation in home prices in different sections of the country.

Congress is now studying a wide variety of possible changes to the bankruptcy laws and some modifications over the next year seem likely. For now, Californians have available to them a substantial home equity exemption.

April 1999.
Reprinted with permission of the The Orange County Register.