Equity is a fairly simple concept that many people do not fully understand. Put simply, “Equity” is the fair market value of your property less the dollar amount of any liens or encumbrances against the property. Here is an example to illustrate:
Billy goes to Jack the mortgage broker to finance the purchase of a new home. In 2012, Billy’s new home is worth approximately $200,000. Billy, following the advice of most financial gurus, puts down a nice 20% down payment and financed the rest to the tune of $160,000. After making a few payments, Billy succumbs to a disabling illness that prevents him from drawing an income. With no disability insurance and shoddy health insurance at best, the majority of the family’s finances are being diverted away from maintaining an average lifestyle to paying off the astronomical medical bills Billy has incurred. Enough is enough, and Billy decides he needs a fresh start after his recovery. He contacts his bankruptcy lawyer, who advises him to enter into a Chapter 13 because he has significant “equity” in his home. In this case, his home is worth $200,000 and the first mortgage is in the amount of $160,000. The difference between the two numbers is the amount of equity Billy has in his home. If Billy were to file a Chapter 7 bankruptcy, the Trustee could attempt to sell his house and distribute the proceeds to Billy’s unsecured creditors.
Fortunately, Billy hired an experienced Atlanta bankruptcy attorney (shameless plug) who counseled him to file a Chapter 13 to allow him to catch up on his past-due mortgage payments and pay off the remainder of his debts over time at a significantly reduced rate. A note about Billy’s situation: In some cases, a Chapter 7 Trustee will not want to waste time with liquidating Billy’s home because Billy’s homestead exemption of $10,000 plus the costs of sale will eat into any distribution amount.