Pay off homestead before bankruptcy? Not so fast, you could lose out

Posted on Jan 06, 2014

In Texas most residents enjoy an unlimited real property homestead exemption, that is, in an urban area a single person or a couple can claim up to 10 acres of land and all improvements as safe from creditors, so long as it is used as a homestead (100-200 acres in a rural area). But there is no exemption for cash or "cash equivalents" such as stocks and bonds, money in the bank, etc.

Therefore, people in debt trouble are tempted to take what cash that they have, and pay it towards (or pay off) the mortgage on their home, and then file bankruptcy. If you are thinking of possibly doing this, find an experienced bankruptcy attorney to advise you.

In 2005, the Bankruptcy Code was amended by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) to provide in Section 522(o) that if in the 10 years before you file bankruptcy, you put money that would not have been exempt, towards your homestead, with the intent to "hinder, delay or defraud" your creditors, the value of that property is not exempt.

So if that is why you paid the money towards your mortgage, for example, and the bankruptcy trustee or a creditor objects and the court agrees with them, then they would be able to sell your homestead, pay off any mortgages, take the money that you had paid down in anticipation of filing bankruptcy, and give you the rest. Not a good result!

In a recent court case from the U.S. Bankruptcy Court for the Southern District of Texas, Houston Division, a widow unwisely used some of her deceased husband's life insurance money to invest in a pizza business, which failed. She was also on the hook for the debts of the business. In 2012 she paid $240,000 towards her home mortgage on her home in Magnolia, Texas, and then filed bankruptcy in 2013. In re Love-Baker, Bankr. SD Texas 2013.

The trustee and a bank objected using 11 USC Sec. 522(o), saying that she paid the money towards her home to avoid creditors. But the Bankruptcy Court said no, after the debtor testified that the only reason that she did it, was because she had received investment information from 3 different investment firms that the stock market was going to tank, and there were other uncertainties in the market.

So it worked out for the debtor in this case (at least so far, there could be an appeal), but don't count on it in every case. Before you pay money down on your homestead mortgage before filing a bankruptcy, consult with an experience bankruptcy attorney. 

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