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.
Simple Formula: Equity = Fair Market Value − Outstanding Liens
A Real-World Example
Let's look at an example to illustrate how equity works in practice. Billy purchases a new home worth approximately $200,000. Following sound financial advice, Billy puts down a 20% down payment and finances the rest—$160,000.
After making a few payments, Billy unfortunately faces a disabling illness that prevents him from working. With limited disability insurance and mounting medical bills, the family's finances are being diverted away from maintaining their lifestyle to paying off astronomical medical expenses.
Billy decides he needs a fresh start after his recovery and contacts a bankruptcy lawyer. The attorney advises him to consider a Chapter 13 because he has significant "equity" in his home.
Calculating Billy's Equity
In this case:
- Home value: $200,000
- First mortgage balance: $160,000
- Equity: $40,000
Why Equity Matters in Bankruptcy
If Billy were to file a Chapter 7 bankruptcy, the Trustee could potentially attempt to sell his house and distribute the proceeds to Billy's unsecured creditors. This is why understanding your equity position is critical before filing.
Fortunately, Billy hired an experienced Atlanta bankruptcy attorney who counseled him to file a Chapter 13 instead. This allows 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.
The Role of Exemptions
It's worth noting that in some cases, a Chapter 7 Trustee may not want to liquidate a home if the homeowner's exemption plus the costs of sale would eat into any potential distribution amount. Georgia's homestead exemption can protect a significant portion of your home equity.
Understanding your equity position in all of your assets—not just your home—is essential when considering bankruptcy. An experienced bankruptcy attorney can help you calculate your equity and determine which chapter of bankruptcy is right for your situation.
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