Characters
- Debtor: person filing for bankruptcy
- Creditor: person or entity who the debtor owes
- Trustee: third party responsible for overseeing the bankruptcy case
Bankruptcy Overview
Bankruptcy allows people with overwhelming debt and no safety net the opportunity to seek financial relief. The legal process allows the debtors to experience a “fresh start” and provides creditors with repayment abilities.
Before we dive into how bankruptcies affect a reverse mortgage, it is important to understand bankruptcy exemptions as they relate to home equity. When filing for bankruptcy, many of the debtors assets are protected (exempt); however, the laws and limits on exempt assets differ by state. For this reason, it is beneficial to seek legal advice when considering bankruptcy.
Typically bankruptcy is complete through liquidation (chapter 7) or reorganization (chapter 13). In the case of chapter 7 bankruptcy, the debtor loses equity by providing a trustee the rights to liquidate a nonexempt property in order to pay back the debt. When it comes to chapter 13 bankruptcy, the debtors are able to maintain nonexempt equity in their home through monthly payments to their creditor over the next 3-5 years.
Can I take out a reverse mortgage if I have a current or recently closed bankruptcy?
A borrower may qualify for a reverse mortgage, even if their credit report discloses an active or recently closed bankruptcy as long as they meet the following guidelines.
Chapter 7
The borrower will be eligible to take out a reverse mortgage on their current home if the bankruptcy has been dismissed or discharged prior to closing. The borrower will not be required to provide any additional documentation if at least one year has passed since the credit report dates the dismissal or discharge. However, additional documentation will be required if the borrower wishes to take out a reverse mortgage before a year has elapsed or the credit report does not note the dismissal or discharge date. Additional documentation includes a judge signed court order and the discharge schedule.
This waiting period is extended to three years if an FHA insured loans was included in the chapter 7 bankruptcy and the borrower wishes to take out a HECM or any other FHA loans.
Chapter 13
A borrower with a chapter 13 bankruptcy is permitted to take out a reverse mortgage once all liens against the property and any other federal debt are paid off. A judge must also sign off an approval note verifying that the borrower is not required to pay off the bankruptcy to proceed, meaning they are still responsible for their monthly bankruptcy payments. The note must specify a rate, keeping in mind that the loan will not close if the specified rate is lower than the current closing rate.
Can I file for bankruptcy if I have a reverse mortgage?
Most of the time, reverse mortgage loans enable elderly homeowners to pay off any outstanding debts. However, if substantial debts remain, a reverse mortgage borrower is generally able to file for bankruptcy.
Filing for bankruptcy will not discredit a reverse mortgage, but taking on more debt will cause many lenders to stop making payments or block the line of credit. If the borrower needs access to these blocked funds, they may seek court approval. Otherwise the lender will typically unfreeze payments and open the line of credit once the bankruptcy case closes.
Although it is rare, some reverse mortgage contracts consider bankruptcy an event of default that can trigger foreclosure. Occasionally, lenders won’t act on this clause. However, if they choose to start the foreclosure proceedings, they must file a motion with the bankruptcy court.