A reverse mortgage is a fairly new financial product marketed to seniors looking for a way to supplement their incomes. Unfortunately, sometimes people with these types of loans get into financial binds that result in them filing for bankruptcy. Although the loan pays money to the debtor (rather than the debtor paying on the loan), this type of mortgage is still considered a debt and is treated like other secured debts you may have. However, there are three things you must be prepared for when filing bankruptcy while you have an active reverse mortgage.
Payments Will Stop
Reverse mortgages are set up similar to lines of credit. The homeowner takes out a mortgage based on the equity in his or her home. Instead of issuing one lump sum payment, the mortgage company sends small monthly payments to the debtor for a certain period of time (typically the balance of the person's life).
When the debtor files for bankruptcy, though, these payments will stop. As mentioned before, reverse mortgages are debts. Each payment made to the homeowner increases the debt owed, and the bankruptcy court typically restricts debtors from acquiring new debt or increasing their debt burdens while their cases are active.
This can be problematic for people who depend on the money they receive from reverse mortgages to maintain their quality of life. If you really need the money, you can talk to the trustee about allowing the reverse mortgage company to continue making the payments while you case is ongoing. The trustee may approve continued dispersals in situations where there is an obvious need and you intend to reaffirm the debt.
Reverse Mortgage Lien Doesn't Protect the Home
Some people believe that as long as there is a lien on a home that the bankruptcy court cannot sell it to pay creditors. This is not the case at all. If your home has equity that is not covered by federal or state bankruptcy homestead exemptions, the trustee can and will sell your home, pay the mortgage loan, and use the balance of the sale to pay off the rest of your creditors.
For example, say your home has a market value of $200,000 and the reverse mortgage lien is $150,000. The federal bankruptcy homestead exemption is only $22,975, which will leave $27,025 of home equity available to pay off creditors. The trustee may sell the home to capture that money and add it to your bankruptcy estate.
Prior to filing for bankruptcy, you'll need to take time to determine if the home is at risk of being confiscated by the court by getting an estimate of the home's market value and subtracting the balances of any traditional and reverse mortgage liens. If the balance exceeds the property exemptions you qualify for, then you should be prepared to move out of the home.
The Loan May Be Called In
Reverse mortgage loans typically don't have to be paid until the debtor dies, sells the home, or permanently moves out. However, some reverse mortgage companies have clauses in their contracts that state the filing of bankruptcy will also cause the loan to immediately come due.
Whether or not the bankruptcy court allows this depends on the particulars of the case. For instance, if the trustee planned on selling the home and paying the debt anyway, then the court may allow the reverse mortgage company to make a claim for the full balance. In most cases, though, courts have denied requests by companies that have attempted to enforce this element of their contracts because it conflicted with the protection provided by bankruptcy laws.
In either case, it's a good idea to connect with a personal bankruptcy attorney for advice on how best to handle these and other situations that may arise as the result of filing bankruptcy while there is an active reverse mortgage on your home.