It’s not unusual for us to meet with individuals whose financial condition is best described as land rich, but cash poor. These are usually people who have lived in their home long enough to have built up significant equity but who must pay for their everyday needs from a fixed monthly income. A little Social Security income, a small monthly pension, perhaps some retirement savings, and a low-wage part-time job might all add up to a few thousand dollars each month – enough to survive, but not enough to ever really stop worrying.
In households that also are carrying a load of debt from credit cards or medical bills, the monthly income may not be enough. For people in this situation, a reverse mortgage becomes an attractive way of generating some income from the equity in the house while remaining in their home. But sometimes individuals come to us when things still aren’t working out and they are considering bankruptcy to obtain debt relief.
Filing for bankruptcy while holding a reverse mortgage contract has some complications. Bankruptcies and reverse mortgages are not necessarily mutually exclusive, but it is a pairing that requires close consideration of your situation and your financial goals.
At the Sasser Law Firm, our board-certified bankruptcy lawyers have more than 20 years of experience guiding people through the bankruptcy process and helping clients overcome financial setbacks. Contact us today to set up a free consultation.
What is a Reverse Mortgage?
If you do not already have a reverse mortgage, you need to understand the benefits and limitations of this financial vehicle. We have found that some people with reverse mortgages do not fully understand the contracts they have entered into.
In a reverse mortgage, the bank pays you for the equity you have in your home and, at the end of the term of the contract, you have increased the encumbrance owed to the bank in relation to your home. But the bank only takes ownership if there is a foreclosure which occurs upon your relocation, death or a default under the loan (e.g. failure to pay property taxes or maintain insurance).
You may be paid with monthly payments, a lump sum, or as needed through a line of credit. You are not required to repay the loan while you are living in the home and have not defaulted on the loan terms. The bank is paid after you die through foreclosure or if your heirs sell the home and pay off the mortgage loan or your heirs pay off the loan. You may repay the line of credit to replenish it, and it will increase each year as the home’s value increases. Before entering into a reverse mortgage, you should know why you want the money, whether for monthly income, to pay for an immediate need or for financial security.
To qualify for a reverse mortgage:
- At least one of the homeowners must be 62 years old or older
- There must be a certain amount of equity in the home. Most lenders require at least 50% equity.
- You must demonstrate the ability to make property tax and insurance payments.
What you can borrow – or the full amount of payments, lump sum or credit line you’ll receive – will be based on the amount of equity in the home, current interest rates and your age. The older the borrowers, the more they can receive.
In the end, the bank pays you less in a reverse mortgage than your house is worth so that, when they sell it, they make a profit. You encumber the home and diminish the equity but get to stay in it during your lifetime. Meanwhile, you may benefit from the income, which you may use as you wish.
Before pursuing a reverse mortgage, you must be sure you can make the property tax and insurance payments, which are part of the escrow fund in many traditional mortgages. If you fall behind, the bank could foreclose. This may lead you to ask what options you have if you have a reverse mortgage but are drowning in debt. Can you declare bankruptcy and not lose your home? The answer is maybe depending on the facts and the chapter of bankruptcy you choose
How Does a Reverse Mortgage Affect Chapter 7 or 13 Bankruptcy?
The immediate response to a bankruptcy filing is that the bank will generally suspend the reverse mortgage payments.
The bank holding the reverse mortgage will not be able to foreclosure even if the debtor has defaulted on the obligation.
Chapter 7 bankruptcy sometimes results in a debtor losing non-exempt assets to generate funds to pay debts. The North Carolina homestead exemption is $35,000 in equity. Chapter 13 bankruptcy is a reorganization available to individuals who have income. Under Chapter 13, the debtor proposes a repayment plan to pay all or a portion of their debt but is able to retain their assets.
If you have more equity than you can exempt, the bankruptcy trustee assigned to the case would sell the house, give you your $35,000 for exempted equity, and distribute the remaining proceeds to creditors, including the reverse mortgage holder. But if there is little equity available, it may not be worthwhile for the bankruptcy trustee to sell the home.
If your circumstances allow, you could pursue reorganization under Chapter 13 instead of Chapter 7 liquidation of debt. Under Chapter 13, you may restructure your debt and develop a repayment plan to address your debts over three to five years.
Under Chapter 13 bankruptcy, if you owed property tax and insurance, the payment plan would halt foreclosure as long as you continue to meet the terms of the bankruptcy agreement. However, nonexempt home equity will count as assets and affect your monthly payment amount. Specifically, the amount of nonexempt equity will need to be satisfied through the three- to five-year payment plan.
Depending on how long you have had a reverse mortgage, you might be able to put off filing for bankruptcy until the reverse mortgage payments have reduced your equity to the point that all or most is exempted.
An experienced, board-certified North Carolina bankruptcy attorney from the Sasser Law Firm can help you evaluate how a bankruptcy would affect your reverse mortgage and the best course of action for you to take. We provide legal representation to individuals and businesses in need of bankruptcy protection in Cary, Raleigh, Holly Springs, Garner and elsewhere in Wake County as well as Harnett, Johnston, Durham, Orange, Granville, Vance, Franklin, Warren, Nash, Lee, Chatham, and Moore counties.