Most homeowners have probably at least heard of the homestead exemption. Many don’t really know how it works, however.  The homestead exemption protects up to $150,000 of equity in your home from the claims of creditors (with some important exceptions that I will discuss in a moment).

Recently some advocates for restricting the authority of homeowners’ associations have promoted legislation that would make the homestead exemption effective against liens for unpaid homeowners’ association assessments. They contend that homeowners whose homes are subject to homeowners’ association liens are being unfairly deprived of their homestead exemption.

What does it mean when we say that the homestead exemption protects up to $150,000 of equity in your home? It means that up to $150,000 of equity in your single family residence, condominium, co-op apartment, or land with manufactured home is not subject to the claims of creditors. If you own your home without a mortgage and its current market value is less than $150,000, it is completely exempt from claims of creditors. If you own your home without a mortgage and it is worth more than $150,000, your creditors can take it to satisfy your debts, but they have to give you the first $150,000.

To fully explain how the exemption works, a basic familiarity with the debt collection process is necessary. If a creditor pursues a lawsuit against a debtor, the creditor’s objective is to obtain a judgment against the debtor. After obtaining the judgment, the creditor will usually record the judgment in the office of the county recorder of the county where the debtor lives. The reason for recording the judgment is that the recorded judgment becomes a lien against any real estate the debtor owns in that county.

The creditor can enforce the lien of the judgment by either undertaking the legal process for a sheriff’s sale of any real estate the debtor owns, or waiting until the debtor sells any of his real estate. Now, let’s assume that the judgment lien is $100,000, the only real estate the debtor owns is his house, and the house is worth $200,000. If it is sold at a sheriff’s sale, or if the debtor sells it while it is subject to the judgment lien, the creditor gets only $50,000, while the debtor gets the remaining $150,000.

The debtor’s $150,000 remains exempt from the judgment lien (and the claims of any other creditors) as long as he promptly invests the money in a replacement residence. In our example, then, he still owes the creditor $50,000, but the creditor can’t collect the remaining debt from a sale of the debtor’s home.

In years past, in order for the debtor to assert his rights under the homestead exemption, it would have first been necessary for him to record an affidavit declaring that his home was subject to the homestead exemption. That requirement was done away with several years ago, although you can still do it (or a creditor can demand that you do it) if you own more than one house and it isn’t clear which one you claim as your residence for purposes of the homestead exemption.

In the above example I assumed that the debtor’s home had no mortgage on it. I did so only to keep the explanation simple. The presence of a mortgage doesn’t change how the homestead exemption works. The debtor’s exemption attaches to his equity, that is, the difference between the value of the property and the amount he owes on the mortgage.

There is an important distinction between a mortgage and a judgment lien, however. If the debtor’s equity in his home is less than the amount of the homestead exemption, the homestead exemption prevents the creditor from using a sheriff’s sale to satisfy the judgment lien. If the debtor doesn’t pay his mortgage, however, the homestead exemption doesn’t prevent the mortgage lender from forcing a sale of the property to satisfy the mortgage. The distinction arises from the fact that the mortgage, unlike the judgment lien, is a consensual lien, i.e. it was placed against the property with the consent of the debtor. The debtor agreed to let the mortgage lender place the lien against his home in exchange for the mortgage loan, so he shouldn’t then be able to claim that his equity is exempt from that lien.

The idea that the homestead exemption should be effective against liens for unpaid homeowners’ association assessments is contrary to the concept of the homestead exemption as being ineffective against consensual liens. To those who say that a lien for unpaid homeowners’ association assessments is not consensual, the response is that they agreed to it when they bought a house in a subdivision governed by documents granting such a right to the association. If you don’t want to be subject to a homeowners’ association, don’t buy a house in a subdivision that has an association (haven’t I said that before?)

Legislation was proposed, but did not become law, in the current session of the Arizona Legislature that would have applied the homestead exemption to homeowners’ association liens for unpaid assessments.  The practical application of such a law would be to make it impossible for a homeowners’ association to collect unpaid assessments from homeowners who have less than $150,000 equity in their home, unless the association can collect the assessment from other assets of the homeowner.

Besides consensual liens, the other important category of liens that the homestead exemption doesn’t cover is tax liens. Not surprisingly, legislative bodies have concluded that they don’t want to make most taxpayers’ largest single asset exempt from the collection of taxes. So if you don’t pay taxes, the taxing authorities can put a lien on your house and enforce that lien without regard to the homestead exemption. The legislature can do this because they make the rules on both the homestead exemption and the collection of taxes.

I don’t expect the advocates for restricting the authority of homeowners’ associations to give up on the idea of making association liens subject to the homestead exemption just because they didn’t get it this time.  I wonder, though, if the anti-homeowners’ association movement is starting to lose steam.  Most people know by now that there are advantages and disadvantages to living in a neighborhood governed by an association, and that there are alternatives to buying a house in one of those neighborhoods.  I have seen house ads that say “no association,” clearly implying that at least for some prospective buyers, the absence of a homeowners’ association is a positive feature. When consumers vote with their feet, the market responds.

Just remember that if you choose a house in a neighborhood that is governed by an association, you can’t rely on the homestead exemption as a way to avoid paying the assessments.