Reverse Mortgages as an Alternative to Bankruptcy

Reverse mortgages can be a good option for older folks with debt problems who are “asset rich and cash poor.”

What’s a reverse mortgage?

A reverse mortgage is a mortgage in which a person, aged 62 or older, uses the equity in her home for a loan. The difference is that (1) the borrower has no personal liability for the loan and (2) the loan is not due until the borrower dies. After death, the lender simply forecloses on the home, and there is no deficiency balance assessed against the probate estate of the borrower. If the borrower’s devisees (those named in his Will) or heirs (those who would take if he doesn’t have a Will) desire to retain the home, they may pay the balance due on the reverse mortgage. In most cases, that simply means that the children have the right to surrender the home or to pay off the mortgage balance owing.

Give me an example of when a reverse mortgage might be used

Let’s say a person has a home worth $150,000 here in South Carolina. Under South Carolina exemptions, she can exempt (protect) $56,150. Let’s further assume this client has $50,000 of credit card debt and a limited income of $1,500 per month which only covers basic living expenses (taxes, utilities, food, clothing, medicines, etc.). (For a detailed list of South Carolina exemptions, see “Bankruptcy Exemptions: The Numbers.”)

Neither Chapter 7 nor Chapter 13 work

The client would not want to file a Chapter 7 (liquidation bankruptcy) because the Chapter 7 trustee would sell her home and pay her the allowable exemption of $56,150. That leaves the client homeless having to rent for the rest of her life. As for Chapter 13 (a payment plan bankruptcy), that won’t work because for the client to keep her home, she’d need to repay the entire $50,000 of debt over five years. (That’s called “liquidation analysis” and means that in Chapter 13 creditors can’t receive less than what they would receive in a Chapter 7 bankruptcy.)

Doing nothing doesn’t work, either

The problem with not addressing the debt problem is that the creditors will eventually obtain judgments on the home and have the right to have it sold to satisfy those debts. Doing nothing essentially works like Chapter 7, but would be a longer, more painful process.

Debt settlement may be the only option

I wrote about the benefits of debt settlement in “Bankruptcy Alternatives: Debt Settlement.” For an overview of that process, read that post. You can see how someone “asset rich and cash poor” could be helped by obtaining a reverse mortgage, perhaps for a limited amount via an equity line, and then using those funds to settle her debts. In the example above, $50,000 of debt could likely be settled for less than $20,000.

The lesson is this: bankruptcy isn’t your only option in dealing with debt problems. A good bankruptcy lawyer understands that and will work with you to find the right solution to your financial problems.