Homestead exemption might not protect home

Q: We are having trouble paying our bills and are concerned about losing our home. I’ve heard something about homesteading your property so that nobody can take it away through a lawsuit, or something like that. How does that work?

A: When you mention the word “homestead,” some people immediately conjure up images of the Homestead Act of 1862, in which a head of household could gain legal title to a 160-acre tract of public land simply by clearing it, improving it and living on it for five years.

Well, that was a long time ago. Today, each state has its own homestead laws, which are concerned with protecting a certain portion of the property owned by the head of a household from being confiscated and sold to satisfy debts. Some states offer much more homestead protection than others. In 2007, Washington state law was changed to increase the homestead exemption in this state to $125,000, which is about the same as the homestead exemption in other Western states.

In some states, you must file paperwork to claim a “homestead,” but in Washington you don’t have to do anything. The homestead designation is automatic as soon as you occupy a particular property as your permanent residence.

Many homeowners misunderstand the law and think that it provides much more protection than it actually does. Under the Washington homestead law, $125,000 of the equity in your home is protected from a forced sale to satisfy “unsecured” creditors. However, the homestead exemption does NOT protect you from secured creditors, such as your mortgage holder. That is the most common misconception about the homestead law. If you don’t make your mortgage payments, your lender can foreclose and sell your house at auction to pay off the loan regardless of whether you have a homestead exemption because the mortgage is a voluntary secured lien, which means that you put up your home as collateral when you took out the loan.

The homestead law protects you only from unsecured creditors. For example, if you had to pay a $100,000 judgment to settle a lawsuit and your only financial asset was $125,000 equity in your home, the winning party could not foreclose on your home to collect the judgment because the first $125,000 worth of equity is protected by the Homestead law. But if you had $225,000 worth of equity in your home, the winning party in the lawsuit could force the sale of your home, give you the first $125,000 which is protected by the homestead exemption, and keep the other $100,000 as payment of the judgment.

Mortgages aren’t the only exception to the homestead protection.

The following types of liens are also exceptions:

  • Construction liens for work performed on your home.
  • Child support debts.
  • Condominium or homeowners association dues and assessments.
  • Certain debts in a bankruptcy filed by one spouse within six months of the other spouse’s bankruptcy.

As you can see, with all of the exceptions listed above, the homestead exemption has limited application in the real world. The homestead law would discourage someone from suing you if your only asset is a home equity of $125,000 or less, and it may allow you to keep your home if you wind up in bankruptcy court, but don’t count on it to protect you from all of your creditors.

Steve Tytler is a licensed real estate broker and owner of Best Mortgage. You can email him at business@heraldnet.com.

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