How does bankruptcy affect your HELOC?

Impact of bankruptcy on HELOC

Bankruptcy is a last resort for many, but if you're hoping to wipe out your HELOC, Chapter 7 or Chapter 13 may not offer the protection you expect. A HELOC is secured by your home, and if you fail to make payments, your lender can foreclose on your home, even in the event of bankruptcy.

What happens to your HELOC when you file for bankruptcy depends on the type of proceeding and whether or not you used your HELOC. In general, if you file for bankruptcy and don’t have a balance on your HELOC, your lender will usually close out your HELOC (which can impact your credit score). But if your HELOC has a balance, you’re still responsible for repaying it.

Chapter 7 bankruptcy involves liquidating your assets to repay creditors and canceling the remaining balances on some debts. Chapter 13 bankruptcy involves entering a structured payment plan with your creditors to keep your assets and settle your debts.

Both types of bankruptcy come with an automatic stay, meaning your creditors must pause any attempts to collect on your debts. This is a temporary court order that pauses collections while your bankruptcy case moves forward.

If you choose to stop paying on your HELOC, your lender may be able to lift the stay and proceed with foreclosing on your home.

Types of bankruptcy and their effects on HELOC

There are two types of personal bankruptcy that you can file for: Chapter 13 and Chapter 7. Both can affect your HELOC in different ways.

Chapter 13 bankruptcy and HELOCs

When you enter into Chapter 13 bankruptcy, you agree to restructure your debts into a payoff plan. This typically means your bankruptcy attorney negotiates a payment plan with each of your creditors to pay off over three to five years, based on what you can afford.

This type of bankruptcy lets you keep your assets — including your home — as long as you make your payments on time. Your HELOC becomes part of the plan, which means you keep your home while gradually paying down the balance.

Chapter 13 vs. 7: What's the difference?

Chapter 13 lets you keep your home and repay your HELOC through a court-approved plan. Chapter 7 could erase unsecured debt, but your home might be at risk if you have significant equity.

If your home is worth less than what you owe on your primary mortgage, you may be able to strip off your HELOC through a process called lien stripping. This works because the HELOC is no longer secured by any equity, and the primary mortgage lender must be paid first.

In general, Chapter 13 bankruptcy is the way to go if you want to keep your home and remain in (somewhat) good standing with your lender.

Chapter 7 bankruptcy and HELOCs

Chapter 7 bankruptcy is more aggressive. It involves liquidating your assets to cover outstanding debts (both secured and unsecured). Most homes are protected in states that have a homestead exemption, but it’s important to review your state protection limits to ensure you don’t lose your home in this process.

If you have a homestead exemption that protects your equity during bankruptcy, the limits are set by your state. For example, Kentucky only protects $5,000 of equity in Chapter 7 bankruptcy, while Florida protects all of your home equity (if you meet all requirements). This is important to know because a Chapter 7 bankruptcy trustee may sell your home to pay off your creditors with any nonexempt equity you still have.

For example, if you have $200,000 in equity in your home in Kentucky, $195,000 of that equity is not protected. Your bankruptcy trustee could sell your home to cover outstanding debts — including your HELOC — using that nonexempt equity.

Managing your HELOC during bankruptcy

If you’re in the midst of bankruptcy, it’s a good idea to continue to make on-time payments to your HELOC lender. While there is an initial automatic stay to stop lenders from attempting collections, your HELOC lender may eventually be able to lift the stay and foreclose on your home.

And whether you’re in Chapter 13 or Chapter 7 bankruptcy, it can make sense to negotiate with your lender to prevent foreclosure. In Chapter 13 bankruptcy, this is usually part of the bankruptcy process — with your bankruptcy trustee negotiating a payment plan with each of your creditors based on what you can afford.

In Chapter 7 bankruptcy, you may want to reaffirm your HELOC to stop foreclosure proceedings. This reaffirmation process includes negotiating with your lender the terms of your HELOC, including payment amount, term length and payoff amount. Once you come to an agreement, your home will be protected during Chapter 7 bankruptcy as long as you make payments on time.

Staying in close contact with your lenders and bankruptcy attorney is key to keeping your HELOC in good standing and avoiding foreclosure. You may also consider refinancing your HELOC into an unsecured loan to lower your payments and eliminate the lien on your home.

» MORE: Best unsecured loans

Alternatives to bankruptcy for HELOC holders

Bankruptcy isn’t your only option; there are alternatives that can help you manage debt and keep your HELOC in good standing.

• Negotiate with your lenders: Before choosing bankruptcy, it’s a good idea to talk with each of your lenders directly to see if you can get more favorable repayment terms. This can keep your debts in good standing, protect your credit and protect your home.
• Refinance your HELOC: If you want to remove the HELOC from the picture, you may consider refinancing with a personal loan. This removes the lien on the home, but you might pay more in interest.
• Consider debt management: Credit counselors may be able to help you negotiate multiple debts with a single monthly payment plan through debt management. This can help you keep up on your debts and protect your credit score at the same time.
• Consolidate your debts: If you can’t handle ballooning debt payments, you may want to consider debt consolidation. Debt consolidation loans help you pay off multiple debts, lower your interest rate and potentially lower your monthly payments at the same time.