• Filing bankruptcy under Chapter 13 can strip out home equity debt.new home image by steven Husk from Fotolia.com
  
  As many as 4 million homes may go into foreclosure in 2010, according to Ilyce Glink, writing in CBS Money Watch. Rising unemployment and falling home prices have put some homeowners in a bind. They cannot afford to pay their mortgage payments, but their house is worth less than the mortgage balance. Homeowners who took out equity loans during the housing boom--roughly 1995 to 2007--particularly face this problem, and their available choices may come down to walking away from the house and letting it go into foreclosure, or filing for bankruptcy.
  
  

Secured Debt and Unsecured Debt

• In a Chapter 7 bankruptcy filing, you will ask the bankruptcy court to discharge most or all of your debt. Except for the $20,000 homestead exemption, you will lose your house. Unless you have less than $20,000 equity in your residence, you will do better filing under Chapter 13. Chapter 13 distinguishes between secured debt, such as your first mortgage, and unsecured debt, such as credit cards. In a Chapter 13 filing, you will eventually repay most secured debt and you will either partially repay unsecured debt or not repay it at all.
  
  

Conventional Wisdom versus New Realities

• Bankruptcy courts have traditionally viewed home equity loans as secured debt. However, with the unprecedented drop in resale values of U.S. homes from 2007 to 2010, this view has changed. Let us suppose you have a $300,000 balance on a first mortgage, and a $150,000 balance on the home equity loan. Your latest home appraisal is assigned a value of $270,000: the first mortgage balance exceeds the appraised value of your house. Because the first mortgage takes precedence over the home equity loan, you may argue to the court that the home equity loan lender has no real equity in your house and the court should classify the home equity loan as unsecured debt. If you make the presentation in good faith, the court will probably grant your request, and strip out from the repayment plan some or all of the home equity debt.
  
  

Unsecured Debt and Reorganization Timetables

• The court will want you to file a plan that discharges or brings current your priority debt first, such as child support; secured debt, such as your first mortgage, comes next. After setting aside your court-approved living expenses, the court will ask you to use the remainder of your monthly income to repay unsecured debt, including credit card debt and your home equity loan--assuming the court has agreed that the second lender has no actual equity position in the house.
  
  The court will also want you to file a plan that accomplishes its two primary goals--bringing current or paying off priority and secured debt--within three to five years. After making these payments and deducting approved living expenses, you will probably have only a limited ability to repay more than a fraction of the home equity loan and credit card debt. So long as you make a good faith effort toward this goal, the court will discharge you from bankruptcy in three to five years. You will keep your home, and you will owe nothing further on the home equity loan.