Foreclosure of Reverse Mortgages

With a reverse mortgage, older homeowners can use the equity in their home to get cash, but this is often a bad idea. Reverse mortgages are complicated, come with extensive restrictions and requirements, and—under certain circumstances—can be foreclosed. (To learn the upsides and downsides to reverse mortgages, see Is a reverse mortgage or home equity loan better for me?)

Read on to learn more about reverse mortgages and when the lender can foreclose.

Understanding Mortgages

Significant differences exist between traditional mortgages and reverse mortgages.

Traditional Mortgages

With a traditional, forward mortgage, the borrower qualifies for and borrows a large sum of money based on factors such as income, job history, and creditworthiness. Often, a traditional mortgage loan is taken out to purchase real estate. The borrower then has to repay the loan by making monthly installment payments. If the borrower stops making payments, the lender can foreclose. (Learn the basics about foreclosures and foreclosure procedures.)

Reverse Mortgages

Reverse mortgages, on the other hand, are designed to allow elderly homeowners to convert the equity in their homes to income or a line of credit. Reverse mortgages are only available for homeowners who:

• are age 62 or over
• occupy the property as a principal residence, and
• own the home outright or have significant equity in the home.

The Federal Housing Administration (FHA) insures almost all reverse mortgages through its Home Equity Conversion Mortgage (HECM) program. The insurance guarantees lenders that they will be repaid in full when the home is sold. Other types of reverse mortgages exist too—they're called proprietary reverse mortgages—which are private loans backed by the companies that develop them. Proprietary reverse mortgages are usually available only for very high-value homes.

A reverse mortgage is different from a traditional mortgage in that it doesn't require the borrower to make monthly payments to the lender to repay the loan. Instead, loan proceeds are paid out to the borrower according to a plan. The borrower can choose to receive a:

• monthly payment
• line of credit, or
• lump sum (though with a HECM, you're limited to 60% of the loan amount during the first year after closing in most cases).

You can also get a combination of monthly payments and a line of credit.

When Does a Reverse Mortgage Become Due and Payable?

Once a triggering event occurs, the reverse mortgage loan becomes due and payable. This means that the borrower owes the lender the total amount of money the lender has disbursed to the borrower, plus interest and fees accrued during the life of the loan.

Triggering Events

A HECM reverse mortgage loan becomes due and payable when one of the following circumstances occurs.

All borrowers have died. When this happens, the heirs have several options. They may choose to:

• repay the loan and keep the property (generally, with a HECM, the heirs may pay the lesser of the mortgage balance or 95% of the current appraised value of the home)
• sell the property (for at least the lesser of the loan balance or 95% of the fair market value of the home in the case of a HECM) and use the proceeds to repay the loan
• deed the property to the lender, or
• let the lender foreclose.

If you take out a HECM and have a nonborrowing spouse, your spouse might be able to remain in the home after you die, and the loan repayment deferred, so long as certain criteria is met. The rules are complex and different depending on whether you took the loan out before or after August 4, 2014. (Learn more in Reverse Mortgages: Foreclosure Protections for Nonborrowing Spouses.)

The property is sold or title to the property is transferred. If the home is sold or title transferred, the loan becomes due and payable. Generally, if the property is sold, the escrow company will accept the purchaser’s money and pay off the reverse mortgage along with any other liens on the property. If you transfer ownership of the home—for example to a relative—the loan becomes due and payable.

The borrower no longer uses the home as a principal residence. With a HECM, if the property ceases to be the principal residence of the borrower for reasons other than death and the property is not the principal residence of at least one other borrower, the loan becomes due and payable. To resolve the debt, you can correct the matter, pay the balance in full, sell the home for the lesser of the balance or 95% of the appraised value and put the proceeds toward paying off the loan, or complete a deed in lieu of foreclosure. Or else, the lender will foreclose.

The borrower fails to occupy the home for longer than 12 consecutive months because of a physical or mental illness. With a HECM, the borrower can be away from the home—for example, in a nursing home facility—for up to 12 consecutive months due to physical or mental illness; however, if the absence is longer, and the property is not the principal residence of at least one other borrower, then the loan becomes due and payable. Again, to resolve the debt, you can correct the matter, pay the balance in full, sell the home for the lesser of the balance or 95% of the appraised value and put the proceeds toward paying off the loan, or complete a deed in lieu of foreclosure. Otherwise, the lender will foreclose.

The borrower fails to meet the obligations of the mortgage. The terms of the mortgage will require the borrower to pay the property taxes, maintain adequate homeowners’ insurance, and keep the property in good condition. (In some cases, the lender might create a set-aside account for taxes and insurance.) If the borrower doesn't pay the property taxes or homeowners' insurance, or if the property is in disrepair, this constitutes a violation of the mortgage and the lender can call the loan due. The lender must usually allow the borrower to cure the default to prevent or stop a foreclosure.

No Deficiency Judgments

When a lender forecloses, the total debt that the borrower owes to the lender sometimes exceeds the foreclosure sale price. The difference between the sale price and the total debt is called a "deficiency."

Example. Say the total debt owed is $200,000, but the home sells for $150,000 at the foreclosure sale. The deficiency is $50,000.

In some states, the lender can seek a personal judgment against the borrower—or the borrower’s estate—to recover the deficiency after a foreclosure. However, deficiency judgments are not allowed with HECM reverse mortgages.

For More Information

Reverse mortgages are complex and, even after attending a required counseling session before getting one, many borrowers still don’t completely understand all the terms and requirements of this kind of loan. For more information about reverse mortgages, go to www.aarp.org/revmort. To learn more about the HECM reverse mortgage program, go to www.hud.gov and enter "HECM" in the home page search box to find a long list of relevant links. You should also consider talking to a trusted financial planner or elder-law attorney or estate planning attorney before taking out this type of mortgage.

If you need help avoiding a foreclosure, consider talking to a foreclosure attorney.