How does bankruptcy affect a reverse mortgage?
One of the primary reasons for taking out a reverse mortgage is the need for income or a line of credit. Sometimes, however, even after tapping into the value of a home, borrowers have trouble paying their bills, dealing with accumulating debt, or paying a large unexpected expense like medical bills.
If you have a reverse mortgage and decide to file for either Chapter 7 or Chapter 13 bankruptcy protection, the impact the filing has on the loan, and your ability to continue living in your home will be based on many factors.
The type of reverse mortgage you have matters
Most reverse mortgages are Home Equity Conversion Mortgages (HECMs) that are insured by the U.S. Department of Housing and Urban Development (HUD). Under this program, filing for bankruptcy does not cause you to default on the reverse mortgage.
However, bankruptcy courts typically do not allow filers to take on additional debt while they are in bankruptcy protection. That means a filer can no longer access reverse mortgage funds without approval of the bankruptcy court or the trustee monitoring the bankruptcy proceedings. Regular monthly payments one receives from the reverse mortgage will stop. If you established a reverse mortgage line of credit, you would lose access to it.
In some cases, you can continue receiving funds from your reverse mortgage after filing bankruptcy by signing a reaffirmation agreement. This is an agreement between the debtor and a specific creditor and approved by the court. It states that the debtor will not discharge what he or she owes to the creditor but will continue making payments in order to keep certain property. For example, a debtor who wants to keep a vehicle he or she owes money on can do so by agreeing to continue making payments through the reaffirmation agreement. If they fail to make those payments, the creditor can then collect on the debt.
With a reverse mortgage, the reaffirmation agreement will state you intend to repay the loan as previously agreed upon, either after your death or after you move out of the home.
If, instead, you decide to sell your home, then any proceeds from the sale will go toward paying the balance on the reverse mortgage.
Mortgages, including reverse mortgages, are non-recourse loans, which means the lender cannot go after any assets other than your home to repay the loan. Therefore, if you do sell your home and the proceeds are not enough to cover the reverse mortgage loan balance, the lender will not be able to access any other assets to make up the difference.
If you have a proprietary reverse mortgage
If you have a proprietary reverse mortgage, the loan documents will dictate how a bankruptcy filing will affect the loan.
Proprietary reverse mortgages are offered by private lenders, and are not federally insured. Therefore, they do not have to adhere to all of the provisions of the HECM program.
Some private reverse mortgages will treat a bankruptcy filing as a default on the loan, giving the lender the right to demand repayment. The borrower would have to ask for relief from the bankruptcy court to avoid defaulting on the loan.
Your state’s bankruptcy laws will have an impact
Your state’s bankruptcy exemption provisions will also be a factor. Most states have a homestead exemption, which allows homeowners to protect a certain amount of equity in their home from creditors.
Keep in mind that to have qualified for a reverse mortgage, you needed almost 100 percent equity before you obtained the financing. So in some states, you almost surely have more equity in the home than the exemption limit. For example, in Alabama, you can only protect up to $5,000 in home equity from creditors; in Missouri, the exemption is $15,000.
Bankruptcy laws in Iowa and Kansas, on the other hand, shield the entire value of your home from creditors. So if you have a reverse mortgage in these and other states that exempt your home’s full value, or if the equity in your home is lower than your state’s exemption value, your home is fully protected from liquidation. That means the court cannot seize your home or force you to sell it to repay creditors. However, the reverse mortgage will remain in place and must still be paid off when you cease living in the property.
Are you filing Chapter 7 or Chapter 13?
The above information mostly pertains to Chapter 7 bankruptcy, a process by which a filer’s non-exempt assets are liquidated to pay off their creditors.
If you file for Chapter 13, the bankruptcy court doesn’t liquidate any of your property and won’t take your home. Chapter 13 enables individuals with regular income to develop a plan to repay all or part of their debts. The court oversees and administers the payment plan to creditors, typically over three to five years.
Since you must be at least 62 years of age to qualify for a reverse mortgage, it’s likely that the loan proceeds are a primary source of income. If that’s the case and a bankruptcy filing will halt those payments, Chapter 13 protection will likely not be an option. On the other hand, if you can continue receiving monthly payments, then you can use the income to fulfill the obligations of your repayment plan.
If you have a reverse mortgage and are considering bankruptcy, you should first consult your loan documents and discuss your situation with an attorney to understand the full impact of the filing on your loan.