Bankruptcy and Reverse Mortgage: Impact and Considerations

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Different kinds of bankruptcy have different implications for reverse mortgages. If you have a reverse mortgage or are considering one and facing bankruptcy, here is some general information about how a bankruptcy might impact your reverse mortgage. With bankruptcy, every situation is different, and before making any decisions, it’s important to consult a bankruptcy attorney about your own.

Does Bankruptcy Prevent a Borrower From Qualifying for a Reverse Mortgage?  

Bankruptcy is a legal process that helps people discharge and reorganize debts to help pay creditors. A current or previous bankruptcy does not bar borrowers from qualifying for a reverse mortgage. A lender, during the financial assessment, will pull a credit report. The report will indicate whether the borrower is in active bankruptcy or recently closed bankruptcy. 

To be eligible for a reverse mortgage, borrowers must meet certain guidelines based on the type of bankruptcy filed.  

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Chapter 7 Bankruptcy  

This bankruptcy is for individuals who fail to earn enough income to pay off their debts. To pay off their debts, any eligible property must be sold.   

If the borrower has filed or is in a Chapter 7 bankruptcy and wants to qualify for a reverse mortgage, the bankruptcy must be dismissed or discharged before closing. If at least one year has passed since the date of dismissal or discharge, the borrower is not required to produce additional documentation.  

In cases where the borrower wants to qualify for a reverse mortgage before a year has elapsed, additional documentation will be required. The borrower must present a court order signed by a judge stating the bankruptcy will be discharged or dismissed along with the discharge schedule.  

If a Federal Housing Administration (FHA) loan was included in the bankruptcy, the borrower is ineligible for another FHA-insured loan for three years from the date of discharge. Here are a few things to keep in mind:

  • Borrowers can still qualify for a home equity conversion mortgage (HECM) after a Chapter 7 bankruptcy. Whether the borrower qualifies depends on how soon they want to seek a HECM after bankruptcy.  
  • If the loan origination is at least two years since the bankruptcy discharge, the borrower must reestablish good credit or not incur any new credit obligations.  
  • If the loan origination is less than 24 months after the discharge, then the borrower must reestablish good credit and not incur new debt.  
  • If the loan origination is between 12 to 24 months from the bankruptcy discharge, the borrower may be eligible for a HECM if they show reestablished good credit, did not incur new debt, and there are extenuating circumstances.  

Chapter 13 Bankruptcy  

A borrower with a Chapter 13 bankruptcy is permitted to take out a reverse mortgage if they meet the following guidelines: 

  • The borrower must pay off any liens against the property and any federal debt. 
  • The court must provide written permission signed by the judge indicating that the borrower does not need to pay off the bankruptcy to proceed with the reverse mortgage.  

How Will a Current or Past Bankruptcy Impact an Existing Reverse Mortgage?  

Based on the type of bankruptcy you file, the timing of the disposition and distribution of loan proceeds, and your debts and liabilities, it could have various implications on your reverse mortgage. If you have filed for bankruptcy in the past, are currently in bankruptcy, or are considering filing bankruptcy, talk to a bankruptcy attorney to understand the bankruptcy’s implications on a reverse mortgage. 

Does a Bankruptcy Filing Jeopardize Home Equity? 

Equity isn’t a bar to filing bankruptcy, but whether that equity is protected depends on a state’s homestead exemption. The court allows borrowers to keep assets despite the bankruptcy filing. However, what is considered “exempt” differs from state to state. Bankruptcy is a federal law in which some of the allowed exemptions are determined by each state. Some states have no homestead exemption, while others allow a range from none to unlimited.  

To qualify for a reverse mortgage, the borrower must have at least 50% equity equal to at least half of the home’s value. Equity is impacted differently depending on the type of bankruptcy filed, state law, and homestead rights.