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Columns: Bankruptcy Adviser
Justin Harelik Expert: Justin Harelik
Bankruptcy Adviser
When credit is low, lenders' fees are sky high
Bankruptcy Adviser

Cashing out equity in Chapter 13

Dear Bankruptcy Adviser,
I am currently in Chapter 13 and would like to refinance my mortgage. I have $70,000 in equity and would like to cash out about $10,000. Is that possible, and if so, with whom? I was told that if you are still in bankruptcy (even though the payments are taken out of my account monthly) that I could not cash out some equity.

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Also, if I sell my house, do I get to keep the equity to purchase another house or is it taken?
-- Anita

Dear Anita,
The short answer to your question is yes. You can take out equity while in a Chapter 13 bankruptcy. You would need court approval and you would need to show a good reason for the loan.

Unfortunately, this short answer does not address the problem of finding a lender willing to provide that kind of loan. When your credit score is low, you are inside a Chapter 13 bankruptcy and home values are decreasing daily, $70,000 in equity is not very much. The only lenders willing to work with someone in bankruptcy will charge high interest rates and high loan fees.

In the mortgage business, these lenders are called "hard-money lenders." In the outside world, you might have heard them called "loan sharks." While the majority of hard-money lenders follow the law, the law allows them to charge high interest rates and high fees. For example, your interest rate would be at least 18 percent with at least $10,000 in fees.

In the past, lending options were more readily available to a debtor inside a bankruptcy. Home values were artificially inflated so that everyone's homes (even those that could be moved via truck) were appreciating at rates never before seen in our country. Lenders were willing to approve incredibly risky loans because their actual risk was nominal. Once the mortgage loan funded, the lender immediately sold the debt to a third-party investor. As a result, the lender had little or no incentive to make loans that made sense.

Your second question deals with your rights to the equity in your home. Generally, when you sell the property, you must first multiply the current market value of your home by 8 percent. That number represents the cost of selling your home. For example, a home valued at $200,000 will cost around $16,000 to sell.

The remaining equity will be considered an asset of your bankruptcy estate. That equity is protected only if your state bankruptcy laws allow it. Typically, most states allow you to protect at least $35,000 to $50,000 of home equity. Some states, like Florida and Texas, allow you to protect all the equity in your home.

Finally, if you want to sell your property, then the important issue is whether you qualify for a Chapter 7 bankruptcy. In general, people file Chapter 13 bankruptcy because either they do not qualify for a Chapter 7 or they have fallen behind on their mortgage and need to catch up on the delinquent payments. Because I don't know why you filed a Chapter 13, I cannot say specifically whether you will be able to protect your home's equity in a subsequent Chapter 7 filing.

The task is difficult and finding the right lender will be the biggest challenge you will face.

Bankrate.com's corrections policy-- Posted: March 11, 2008
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