Reverse Mortgages and California Bankruptcy

As many of our clients filing personal bankruptcy get older, we often see clients who have taken reverse mortgages on their homes. Either because they needed income to live on or to deal with a spouse’s end-of-life care, I meet with a growing number of bankruptcy clients who have turned to these types of loans in order to get by. And no wonder, the banks have been pushing reverse mortgages aggressively for several years now. Daytime television is now inundated with commercials for reverse mortgages. I’m not going to get into the financial wisdom of these loans in this post, but I do want to focus on how reverse mortgages are treated in bankruptcy, particularly in Chapter 7 bankruptcy.
Reverse mortgages generally fall into different categories. There are those where the homeowner takes a lump sum from her home equity, and those where she might receive monthly payments that accrue as a loan against her home equity. Typically, the reverse mortgage loan becomes due and payable within a specified time after the homeowner’s death. At which point, either the decedent’s estate representative must either sell the property in order to pay off the reverse mortgage loan, or if the estate is unable to sell the property after a given period of time, then the lender will generally have a right to foreclose on the property in order to recover the balance of the loan.
So, what if the homeowner needs to file bankruptcy? In bankruptcy a reverse mortgage loan is treated no differently than any other mortgage or home equity loan, to the extent that the bankruptcy attorney together with his client must provide a current fair market value for the property that is subject to the reverse mortgage and determine the current total payoff balance of the reverse mortgage loan. After determining these values, the bankruptcy attorney must analyze how much equity the bankruptcy client has in the property. The amount of the bankruptcy debtor’s equity is critically important to exemption planning for a Chapter 7 bankruptcy, and is likewise central to a liquidation analysis in Chapter 13 bankruptcy.
Say we have an elderly widow who needs to file bankruptcy in San Jose, California, because she has incurred some large unsecured debts, including credit cards and substantial medical debts uncovered by insurance. She now lives only on social security income. Several years before she and her late husband took out a reverse mortgage on their home in San Jose, which at the time had been paid off and had a value of $450,000. They took a lump sum from their equity of $150,000 to pay for in home nursing care for him and to pay off other debts. Since then it has depreciated significantly and has a current value of $375,000. The reverse mortgage payoff balance has risen steadily over the years as interest has accrued on the loan, and now stands at $210,000. Hence, the bankruptcy debtor now has only $165,000 of equity in the home.
Assuming that our bankruptcy debtor in the example above is over the age of 65, then for purposes of her Chapter 7 bankruptcy in California, the homestead exemption will protect up to $175,000 of equity in her home. She would, therefore, be able to entirely protect her home from the Chapter 7 trustee.
Before filing such a case, however, it is imperative that the bankruptcy attorney communicate with the lender and review the original reverse mortgage contract language to ensure that the mere filing of a bankruptcy case by the borrower will not be treated as an even of default. In my experience, most reverse mortgage lenders will not call their note due solely because of a bankruptcy filing, but again, it is imperative that debtor’s counsel confirm this with the lender prior to filing. Just another reason why if you are contemplating filing bankruptcy in the Bay Area, that you contact one of our experienced San Jose bankruptcy attorneys.