Can I File for Bankruptcy If I Have a Reverse Mortgage?

If you're at least 62 years old, are having financial issues, and have equity in your house, you might be considering taking out a reverse mortgage, filing a bankruptcy case, or both. Although both will address money issues, using both together might cause you to run into a problem, especially if you still have significant equity in your house. Why? You might put that equity in jeopardy by filing for bankruptcy.

How Does a Reverse Mortgage Work?

Many older adults use reverse mortgages as a way to manage house payments or to tap into their home equity without having to put the house on the market. Depending on the lender and the program you choose, you can structure your reverse mortgage in a variety of ways. For instance, your program might let you:

• eliminate your monthly mortgage payment
• receive a lump sum payment
• enjoy a monthly income, or
• have access to a line of credit.

All of these options draw on the equity in your house. You'll qualify if you're at least 62 years old and meet certain income, credit, and equity guidelines.

The Reverse Mortgage in Bankruptcy

If you have a reverse mortgage and you're considering filing for bankruptcy, you're right to wonder whether you might face some problems. For instance, you'll want to know whether you'll default on your reverse mortgage when you file, as well as the ramifications of doing so.

Three other questions to consider before filing for bankruptcy include whether you'll be able to:

• protect the equity in your house
• retain access to any remaining lump sum payments, and
• withdraw your equity.

Is Your Home Equity Safe?

Typically, you must have equity equal to at least half the value of the property to qualify for a reverse mortgage. The problem is that most states don't allow you to protect (exempt) substantial amounts of equity in bankruptcy. In short, you'll lose your nonexempt equity in a Chapter 7 bankruptcy, and have to pay for it in a Chapter 13 bankruptcy.

Here are some bankruptcy concepts you should understand:

• Bankruptcy exemptions. You can keep many of your assets when you file for bankruptcy. But your state limits the type and value of property you can exempt. Some let you protect as little as $5,000 in home equity while a few others give you a homestead exemption that will cover 100% of your equity. (Go to Bankruptcy Exemptions by State to find out how much you can protect.)
• Chapter 7 bankruptcy. In a Chapter 7 bankruptcy case, you can keep your exempt equity. However, if you have more than you can exempt, the bankruptcy trustee assigned to the case will sell the house, give you your exempt equity, and distribute the nonexempt equity to creditors.
• Chapter 13 bankruptcy. By contrast, in Chapter 13 bankruptcy, your property will be safe, but there's a catch: The nonexempt home equity will affect your monthly payment amount. Specifically, you'll have to pay an amount equal to the nonexempt equity (if not more) through a three- to five-year plan.

It might be worth waiting to file the bankruptcy case until the reverse mortgage payments or withdrawals reduce your equity. The longer you wait, the less exempt equity you'll have in a future bankruptcy case.

Is Your Equity Withdrawal Safe?

If you took your equity in a lump sum, and still have the money in a deposit account, it won't be protected under the homestead exemption in most states. Or, in the best case scenario, it will be subject to the exemption for a short period—typically six months. If it's not exempt under the homestead exemption, you'll have to protect it under another exemption (and finding another exemption will likely be difficult).

Will Filing Bankruptcy Cause a Mortgage Default?

Under some reverse mortgage contract provisions, filing a bankruptcy case is considered an event of default (breach of contract) that can trigger foreclosure. These contracts are rare, but they still exist. If your reverse mortgage has this kind of clause, there's a chance your lender won't act on it during your bankruptcy.

To enforce the default and foreclose during bankruptcy, the lender must file a motion with the bankruptcy court for permission to start foreclosure proceedings. If you still have equity in the property, the bankruptcy court will likely deny the lender's motion; however, there's no guarantee. Also, the lender might be able to initiate foreclosure once the bankruptcy case closes.

Will You Receive Reverse Mortgage Payments During the Bankruptcy?

Many lenders will stop making payments to you or will block your access to a line of credit when you file for bankruptcy because you're taking on more debt with each payment. Ordinarily, the lender will resume payments after the bankruptcy case closes, but if you can't wait, you can ask the court to allow the bank to make payments during the case.

Meet With an Attorney

For most, home equity is the largest asset that an individual possesses. While this article should provide helpful information, it isn't legal advice. You should contact a knowledgeable bankruptcy attorney for an assessment of your particular situation.