3 ways to lose a HELOC, keep the house

Justin HarelikDear Bankruptcy Adviser,
I have a line of credit secured by my house (a home equity line of credit, or a 2nd mortgage). We have a 1st mortgage as well. If I declare Chapter 7 bankruptcy, will the line of credit (like a credit card with no more credit available) be dismissed through a bankruptcy? Thank you for your assistance.
-- Vicki

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Dear Vicki,
I am asked this question every single day. I always understand where the question is coming from -- a position of desperation. You are desperate to keep your house, but you cannot afford to make payments on the line of credit.

The 1st answer is "no" you cannot eliminate a home equity line of credit, or HELOC, that is secured by your house in a Chapter 7 bankruptcy while keeping the house. That line of credit must be paid in order to retain your property.

There are 3 other solutions: 1 that is inside bankruptcy and 2 outside.

3 ways to lose a HELOC but keep the house:

  1. File for Chapter 13 bankruptcy.
  2. Settle with the lender holding the credit line.
  3. Modify the line-of-credit payment.

1. Chapter 13 bankruptcy

Like many people today, you might not have any equity in your home. In fact, you might be so far upside down that the value of your house is worth less than what you owe on your 1st mortgage. For example, you owe $250,000 on the 1st mortgage, but the current fair market value of your property is only $200,000.

In a Chapter 13 bankruptcy, known as a reorganization bankruptcy, you could have the HELOC, or 2nd mortgage, eliminated -- wiped out -- after you complete your case. The catch is a Chapter 13 bankruptcy lasts at least 3 years and could take as long as 5 years. The time period will depend on your income.

In that reorganization period, you will make payments to your 1st mortgage lender as well as to the court, or more specifically the trustee assigned to your case. After the period is over, you will eliminate the line of credit and any credit card balances. These lenders might get paid something over the bankruptcy period. However, any remaining balance will be eliminated once you complete the bankruptcy.

2. Settle with the lender holding the line of credit

Recently, quite a few clients have told me that the 2nd mortgage lender has given them a one-time, lump-sum settlement offer. This means the HELOC lender understands there is no equity in the property and that, if it foreclosed, that lender would get paid nothing.

This could be a viable option. Even so, you likely will find it difficult to pay the settlement in 1 payment. You could borrow money from friends or family, but that's risky because it could end your relationship if you fail to pay the money back. Or, you could take the money from a retirement account. If you take this option, you could have tax consequences from the early withdrawal.

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3. Modify the line-of-credit payment

If you are upside down on the property, you could negotiate a modification with the lender. The line-of-credit lender would rather receive something than be forced to write off another loan. You may be in a position to tell the lender that you can afford only so much. If the HELOC lender does not want that payment, you may be unable to afford the house. Be sure that's the case before drawing a line in the sand with the lender.

The options are not great, but a few do exist. You must make an objective decision and not base your decision on emotion. You will need to be diligent and persistent if you decide on options No. 2 or No. 3. You might get only 1 opportunity to work out something with the lender.

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