Nonsense and Bankruptcy Exemptions

I've come to realize that my posts are lacking a certain amount of polish and coherence, so I have decided to make an effort to post more often and to make my posts more pithy and generally more intelligent. After all, I can write very well when I put for the effort.

Now, some more on bankruptcy exemptions.

The Illinois Homestead Exemption, or . . .
punishing those who actually try to pay for their homes.

I touched on this topic with my last post. Bankruptcy clients in the current real estate market (read: down the drain and minced in the garbage disposal) either have (a) zero equity or negative equity, or (b) a ton of equity.

Rarely is there a situation, in my experience, were a debtor has, say, $50k in equity. Most often, in those situations, the debtor would have already tapped that with a HELOC or other form of second mortgage. While practical in theory, these "debt consolidation" 2nd mortgages are just a way to eat into home equity while preserving the unsecured lines of credit that debtors horribly mismanaged in the first place and will quickly resume to horribly mismanage.

In Illinois, the homestead exemption is $15,000 for an individual, and $30,000 for a married couple. Federal exemptions are worth $20,200 , and the rest very by state. Some are as high as $100k or even unlimited (Arizona and Texas, respectively).

So, in general, Illinois has dinky exemptions.

As a policy standpoint, these exemptions do not encourage people to build equity in property, since it it easy to lose your home in the event of misfortune. I had a client who had over $100k in equity, but minimal income sufficient only to pay the small mortgage on the property. The debt level was median, between $40k and $75k, with a judicial lien.

If she had been mortgaged to the hilt, we could have filed ch. 7, avoided the judicial lien, and made her life easy as pie. Instead, she's looking at a 100% repayment ch. 13 at over a $1,000 a month (unfeasible and unaffordable). Or she can sell the house and loose that which she struggled long and hard for.

The results are simply not fair and, more importantly, do not serve the purpose of bankruptcy. One's home is one's castle, and, unfortunately in Illinois, your gate is down if you have equity.

The Lameness of Exemptions in Illinois

In bankruptcy, certain property is exempt from a trustee's taking. Under the Illinois code, 735 ILCS 5/12, certain things of value are exempt. The most typical examples are as follows:

• Homestead Exemption, 735 ILCS 5/12-901: $15,000 of equity for your residence ($30,000 for married couples)
• Wearing apparel, school books, Bible, and family pictures. (735 ILCS 5/12-1001)
  
• Motor vehicle equity: $2,400 (735 ILCS 5/12-1001)
• Trade tools and implements: $1,500 (735 ILCS 5/12-1001)
• Personal Property (divisible): $4,000 (735 ILCS 5/12-1001)

It is time to revisit these exemptions. They have been revised in 2006 and 2008, but they are still too low from a policy standpoint.

For exampe, as a bankruptcy matter, the homestead exemption is either irrelevant or not nearly enough. Debtor generally can't manage their finances at all (i.e., underwater on their 12% adjustable 10 year balloon mortgage) or have some recent disaster (medical illness or job loss) that causes bankruptcy. So when the homestead exemption actually is useful, it isn't enough.

A good example is someone I met with a few weeks ago. Age 62, married, not eligible for medicare or medicaid, no health insurance, pre-existing medical conditions, etc. House is worth $200k (typical for the Chicago suburbs) and is paid off. He keeps food on his table and the lights on because his mortgage is paid off. His $60k in medical bills is either (a) a Chapter 13 payment that is way too high for him to afford at 100% repayment, or (b) requires him to sell his home to pay off, or (c) requires him to take out a HELOC, with payments he can't afford and a credit history that means most banks won't lend to him, despite a 100% security interest.

A chapter 7 would help him out tremendously - except the trustee would sell his house. The solution is simple: let's thriple the homestead. Going to $50k/$100k would help families protect hard-won equity and still give them major protections in bankruptcy.

Another good example of how the exemptions are terrible is blue-collor industry - truckers, landscapers, and the like. These folks are selling their skills, essentially. To use their skills though, they need certain expensive equipment. That equipment makes Ch. 7 generally a bad idea. If your truck is worth $40k, or your landscaper is worth $25k, then it is going to be vulnerable to seizure. Generally, these are the things that those in those industries pay off first, to save on expenses. Paid-off equipment is another $1,000 a month or more in the bank.

Their white-collar conterparts (real estate brokers, attorneys, computers, accountants) who are also in the business of selling their skills, can file ch. 7 much easier, then restart their businesses with even less of an issue.

The solution: make the trade tools exemption unlimited, or nearly so. If you need something to secure your livelihood, exempt it permanently. Don't take someone's fishing rod when they need it to eat.