Bankruptcy isn’t right for everyone. Sometimes debtors may need to resort to their assets, such as using a HELOC, to get out of debt. Many people are too quick to dismiss bankruptcy as an option; however, there are some people for whom bankruptcy is not the best option for dealing with burdensome debt. So, who should consider using a HELOC (Home Equity Line of Credit) to get out of debt?
The only time one should use a HELOC to get out of debt is if bankruptcy would cost more money.
When considering filing bankruptcy, a debtor’s first question is usually: “Will I lose my home?” In ninety-nine out of a hundred cases, the answer is no. Each state provides a homestead exemption that protects a certain amount of equity in a person’s primary residence. Most states define a specific amount of equity; for example, the Colorado homestead exemption is currently $75,000.00. A few states have an unlimited homestead exemption. So, if a Colorado debtor has $60,000 worth of equity, they can still file bankruptcy and not lose their house because the amount of equity falls within Colorado’s $75,000 homestead exemption.
The challenge is when the debtor has too much equity. I recently had a consult with a couple who owed $350,000 on their mortgage, but their home was worth $750,000. They have $325,000 of net equity (equity in excess of the Colorado homestead exemption) in their primary residence. Such a couple is a prime candidate for debt settlement. They had $60,000 in credit card debt and were mostly behind on payments and the debt is in collection. The least costly option for this couple is to tap their home equity to raise funds to negotiate settlements with each of their creditors.
If that couple filed chapter 7 bankruptcy, then the bankruptcy trustee will sell their house and use the equity to pay their creditors in full. If that couple filed chapter 13 bankruptcy, they would have to pay one-hundred percent of their credit card debt over sixty months. However, they could tap their home equity and probably settle that $60,000 for between $25,000 and $35,000.
The only time one should use a HELOC to get out of debt is if bankruptcy would cost more money.