A homestead exemption allows you to retain a certain amount of equity in your home -- and can prevent the sale of your home to repay debts in a bankruptcy. In a Chapter 7, the trustee can make you sell your home if the equity you have in it exceeds the homestead exemption. In a Chapter 13 bankruptcy, the homestead exemption plays a part, too, because if you can exempt all or most equity in your home, you will have to repay less to your creditors. Both federal and state laws provide homestead exemptions. Some states allow you to choose between federal and state exemptions, whereas other states require you to use the state exemption.
A homestead exemption can protect all or part of your equity in your home from your bankruptcy case. For example, if your home is worth $125,000 and you have a mortgage with a $100,000 balance, your equity is $25,000. If your state allows for a homestead exemption of $75,000, you can exclude all your equity from your bankruptcy case. As such, the exemption can prevent the trustee from ordering the sale of your home in a Chapter 7 case. In a Chapter 13 bankruptcy, if you have an excessive amount of nonexempt equity in your home, you'll have to pay significantly more each month to your unsecured creditors than if you could exempt the equity you have in your home.