Reverse mortgages pay a homeowner money for the equity in his property, rather than having the property owner repay the mortgage company for a home loan he took out. This can cause a few wrinkles when a homeowner decides to file for Chapter 7, although the filing process is the same with or without a reverse mortgage. In at least one respect, bankruptcy treats a reverse mortgage just the same as a traditional arrangement.
Chapter 7 is the form of bankruptcy where the trustee takes control of your nonexempt assets and liquidates or sells them to pay off your debts. In the case of your home, two things work in tandem to determine whether the property is exempt from sale -- your equity and your available homestead exemption. Bankruptcy law offers exemptions at both the state and federal level that effectively remove certain property from the trustee’s reach and from distribution to your creditors. In some states, you have the option of using federal or state exemptions, but in others, you’re confined to using the state list.
Your Home’s Equity
Your equity is the difference between your mortgage balance and your property’s value, regardless of whether you have a traditional mortgage or a reverse mortgage. The major difference is that your reverse mortgage balance increases and your equity decreases as time goes by and you draw money from the lender against the property's equity. With a traditional mortgage, your mortgage balance decreases and your equity increases.
Depending on how long you’ve been collecting money on a reverse mortgage, you might have negligible equity left, so your homestead exemption would cover it. But reverse mortgages typically require that you have significant equity in the first place, so if you took one out recently, a lot of equity might still remain – more than you can cover with an exemption. In this case, the trustee can sell your home. Just as with a traditional mortgage, he would pay off the reverse mortgage balance from the proceeds, give you the amount of your exemption in cash, and turn the balance over to your creditors.
The Means Test
Many Chapter 7 debtors have little or no nonexempt property so they lose nothing while their responsibility for their debts is discharged. The law wants to prevent this from happening if you have sufficient income to fund a Chapter 13 payment plan instead. The means test determines the available income you have to pay your debts, and if you earn too much, you can’t qualify for Chapter 7. If your reverse mortgage makes regular payments to you in exchange for your equity, the bankruptcy court takes the position that this is income, which can push you over the line in the means test.
Your Mortgage Payments
The possibility also exists that if your reverse mortgage provides for regular payments to you, as many do, they’ll be disrupted when you file for Chapter 7. You’re not permitted to take on any new debt while you’re in bankruptcy, at least not without getting approval from the court first. Because every payment you receive from your reverse mortgage lender increases the balance of the mortgage, you incur more debt each time you accept a payment. But if you’re able to exempt the equity in your home so it’s not subject to sale by the trustee, you can often sign a reaffirmation agreement with the lender, which pledges to keep the terms of the loan intact. This removes the mortgage from your bankruptcy proceedings, but the court must approve the reaffirmation agreement.
Some reverse mortgage lenders include terms in their contracts that allow them to call the loan due immediately and foreclose if you file for bankruptcy. Although you would file for bankruptcy just the same with or without a reverse mortgage, you might want to take your mortgage contract to an attorney for review before you do to make sure this doesn’t happen to you. After you file Chapter 7, it's difficult -- if not impossible -- to change your mind and pull the plug on the proceedings.
- Bankrate: Is Bankruptcy an Option With Reverse Mortgage?
- Bankrate: Bankruptcy Halts Reverse Mortgage Payments
- The Hilla Law Firm: Reverse Mortgages in Bankruptcy – Will I Lose My Home if I File Chapter 7 or Chapter 13?
- Rubin Lublin: Reverse Mortgages in Bankruptcy (PDF)
- Federal Trade Commission Consumer Information. "Reverse Mortgages." Accessed Mar. 10, 2020.
- National Reverse Mortgage Lenders Association. "Senior Housing Wealth Reaches Record $7.14 Trillion." Accessed Mar. 10, 2020.
- U.S. Department of Housing and Urban Development. "How the HECM Program Works." Accessed Mar. 10, 2020.
- American Advisors Group. "What is a HECM for Purchase Loan?" Accessed Mar. 10, 2020.
- Federal Deposit Insurance Corporation. "Reverse Mortgages: What Consumers and Lenders Should Know." Accessed Mar. 10, 2020.
- Consumer Financial Protection Bureau (CFPB). "What Happens to My Reverse Mortgage When I Die?" Accessed Mar. 10, 2020.
- Consumer Financial Protection Bureau (CFPB). "How Much Will a Reverse Mortgage Loan Cost?" Accessed Mar. 10, 2020.
- U.S. Department of Housing and Urban Development. "HECM Counseling Fees." Accessed Mar. 10, 2020.
- U.S. Department of Housing and Urban Development. "Home Equity Conversion Mortgage Program (HECM) Fact Sheet." Accessed Mar. 10, 2020.
- Consumer Financial Protection Bureau (CFPB). "How Much Money Can I Get With a Reverse Mortgage Loan, and What Are My Payment Options?" Accessed Mar. 10, 2020.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.