How Does Bankruptcy Affect Your HELOC?

Filing for bankruptcy isn’t an easy choice to make. The process can be overwhelming. And, contrary to popular belief, it doesn’t magically make all your debts vanish — even if they’re home-based obligations, like a home equity line of credit (HELOC).

If you haven’t drawn any funds against your HELOC, the process is straightforward: The lender simply closes the line of credit. However, if you have an active balance on your HELOC, the impact largely depends on the type of bankruptcy you file. And filing won’t get you off the hook with HELOC payments.

Here’s everything you need to know about what happens to a HELOC in bankruptcy.

Does a bankruptcy affect an existing HELOC?

When it comes to a home equity line of credit (HELOC) and bankruptcy, two types of filings come into play for individuals. Chapter 7 involves liquidating assets to quickly pay off debts, while Chapter 13 allows for a structured repayment plan to manage debts without losing assets over time.

In both types of bankruptcy filings, one of the initial steps is an automatic stay, which pauses most collection efforts, including those concerning your HELOC. Travis Christiansen, attorney at Boyack Christiansen Legal Solutions, a law firm in St. George, Utah, explains, “The automatic stay says the bank or whoever it is can’t take any collection efforts: You can’t send a notice, you can’t make a phone call, all lawsuits have to stop.” However, this protection is only temporary.

“Because you file for bankruptcy, it means that you personally get a discharge of the promissory note,” Christiansen says. But, he emphasizes, while the automatic stay offers a breather from foreclosure or repossession,”if you want to keep the property, you have to continue making your payments on your home; otherwise, you’re going to lose it.”

In other words, if you wish to retain your home, you must stay current on your HELOC payments. Failing to do so can result in the lender seeking to lift the automatic stay and proceed with foreclosure.

How does a Chapter 7 bankruptcy affect a HELOC?

If you have significant unsecured debts and limited income or assets to repay creditors, Chapter 7 — often called “liquidation” bankruptcy — could be the best option. But you have to take certain steps to safeguard your home.

Here’s why. Most states have homestead exemptions, which protects a portion of your home’s equity from creditors and other liens or claims in case of bankruptcy. However, the dollar amount of the exemption varies greatly from state to state: In California, for example, it’s $600,000; in New York, it’s as high as $179,950; in Kentucky it’s only $5,000 (as of 2024). If your equity exceeds your state’s homestead exemption  — and, given the way rising home values lately have pushed up homeowners’ equity stakes, it well might — a bankruptcy trustee may sell your home to pay off creditors, including your HELOC lender.

So, if you have an outstanding HELOC balance, you need to keep it in good standing. “The homeowner would be able to file a Chapter 7 by keeping their regular monthly mortgage payments current on both the first [mortgage] and the HELOC, and their homestead exemption would protect their home from liquidation by a Chapter 7 trustee,” says Louis J. Esbin, a certified bankruptcy attorney and founder of the Law Offices of Louis J. Esbin, a Santa Clarita, Calif.-based law firm.

He says while you can discharge your obligation to pay the HELOC, you must keep paying the loan if you want to keep the home. By reaffirming the debt with the creditor, you agree to remain liable and continue paying all or part of the debt, even though it would otherwise be discharged in bankruptcy.

Reaffirmation also allows you to renegotiate terms such as reducing your payments, adjusting your interest rate, or lowering the total amount you will need to repay over time. Christiansen points out that homeowners can suggest spreading out missed payments over a year. “Let me reaffirm and keep paying it,” he says. “The banks really don’t want that real estate on their books, and so they will work with you often to help negotiate getting caught up on that stuff.”

How does Chapter 13 bankruptcy affect a HELOC?

Chapter 13 bankruptcy, or reorganization bankruptcy, allows you to keep your property while reorganizing debts into a manageable repayment plan. In this case, your HELOC becomes part of that plan to pay your debt in three to five years.

“Chapter 13 is a really great vehicle for people…to get themselves through it while keeping their assets, keeping their home,” says Esbin.

However, things could get complicated if your home’s market value is lower than the balance on your primary mortgage, aka having negative equity. In this case, you can “strip off” your HELOC in Chapter 13 bankruptcy in a process known as lien stripping. “The court would declare what the value of the property is, and they would say that payments do not need to be made because it’s no longer secure,” says Esbin. If the court approves, the junior lien becomes an unsecured debt, paid off at a lower priority.

In Chapter 13 bankruptcy, reaffirmation is optional because the repayment plan usually addresses the disposal of secured debts. However, you can reaffirm a debt to maintain a good relationship with the lender or ensure the loan terms remain favorable.

“You can either pay it through your plan or pay it out of the plan,” says Christiansen. “But if you’re behind, you can take what you’re behind on those things and very often negotiate it with [the lender] to get caught up over time.”

Is it possible to keep your HELOC after bankruptcy?

Yes, keeping your HELOC after bankruptcy is possible. You have to set up a repayment plan with a Chapter 13 bankruptcy. That will allow you to maintain the line of credit. However, be prepared for the lender to reduce your balance.

“Let’s say you have a $20,000 line and a $10,000 balance. Once you go through bankruptcy, you’re not going to [be able to] say, ’Oh, I can still borrow the additional $10,000.’ They will lower your available credit and then keep capping those balances until they are paid,” says Matt Dunbar, senior vice president of the Southeast Region for Churchill Mortgage. “That’s because the risk of default is still present.”

What strategies can help safeguard your HELOC from bankruptcy?

There are several strategies to help you safeguard your HELOC if you find yourself heading toward bankruptcy:

• Keep making your monthly payments on time.
• Try communicating with your lender to make adjustments in your payment plan before you file for bankruptcy, making it easier to manage your finances.
• Consider refinancing your HELOC into a fixed-rate loan before filing, to make payments more stable.
• Speak with a bankruptcy attorney to review your options for safeguarding the HELOC and your home.

How does bankruptcy affect your ability to get a HELOC?

Bankruptcy can stick around on your credit report for quite a while— seven years for Chapter 13 and ten years for Chapter 7. This can seriously impact your credit score, making it tough to qualify for new credit products, including HELOCs.

“Bankruptcy is just a matter of getting your credit rebuilt to the point that you can get lending, and it can be done in a two to three-year time period,” says Christiansen. He suggests paying bills on time or getting a secured credit card to get your credit record back on track.

Remember, loan criteria can vary depending on the lender, so it’s worth contacting one directly. Dunbar recommends asking questions like, “What are the rules? How long do I need to be outside of bankruptcy? What do I need credit-wise to qualify for a HELOC in the future?” He says any good lender should be able to provide you with that information.

You can also enlist the help of credit counseling agencies to develop a plan to rebuild your credit.

Bottom line on HELOCs and bankruptcy

Deciding which type of bankruptcy is right for you requires understanding how it will impact your financial situation before and after filing. Chapter 7 aims to eliminate debts altogether, while Chapter 13 focuses on setting up a plan to repay them. Each has its own pros and cons, so you’ll want to think through your situation carefully before deciding which one is best for you.

“It’s not the end of the world,” says Dunbar. “Bankruptcy protection is there because circumstances out of your control happen and you need to protect your income and assets. This is a circumstance that you’re managing and mitigating, and once it’s over, you can start fresh.”

FAQ

• How does bankruptcy affect your home equity?

  Bankruptcy itself doesn’t impact the value of your home equity stake. But it can cause you to lose it, by forcing the sale of your home to repay creditors, especially if you file under Chapter 7. Even if you keep the home, after bankruptcy,

• How can you tap home equity after bankruptcy?

  After bankruptcy, it will probably be harder to access your home equity through loans or refinancing — due to the filing’s appearance on your credit and financial history, and its negative impact on your credit score. But while challenging, it’s not impossible. You might still be able to get a home equity loan, HELOC, or a cash-out refinance. But it could come with higher interest rates or stricter terms than you would’ve had pre-bankruptcy.

• How does bankruptcy affect your ability to pay your mortgage or home equity loans?

  Bankruptcy can clear out overwhelming debt, especially unsecured debt, making it easier to manage your mortgage and home equity loans. While Chapter 7 liquidates non-exempt assets to pay creditors, Chapter 13 sets up a repayment plan for secured debts, enabling you to keep your home. But bankruptcy can complicate your financial situation if not handled properly, leaving you with outstanding obligations and limited means to pay them.