Homestead law doesn’t protect from all creditors

Question: We are having trouble paying our bills, and we are concerned about losing our home.

I’ve heard something about homesteading your property so that nobody can take it away from you through a lawsuit or something like that.

How do we go about homesteading our house to protect

it if we can’t afford our bills any more?

Answer: When you mention the word “homestead,” some people immediately conjure up images of the pioneers and the Homestead Act of 1862. Under that act, 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.

For example, 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.

If you don’t make your mortgage payments, your lender can foreclose and sell your house at auction to pay off the loan. It can do this regardless of 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 home-owners 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 mainly comes into play in bankruptcies. When they are over their head in debt, many homeowners will let all of their other bills slide in order to keep making their mortgage payments on time.

In bankruptcy court, the judge will let the homeowner keep their house if they are not delinquent on their mortgage and their equity is $125,000 or less.

Bankruptcy judges tend to be fairly lenient with the homestead exemption limit.

For example, if your house was worth $450,000 and the mortgage balance was $300,000, that would be a total equity of $150,000.

But the judge might take into consideration that the homeowner would incur $25,000 or more in real estate commissions and closing costs, plus other selling and moving expenses, and therefore conclude that the “net” equity would be within the $125,000 limit protected by the homestead law.

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 features@heraldnet.com.