A reverse mortgage is a type of loan that allows a homeowner aged 62 or older to borrow against the equity in their primary residence. To qualify, the homeowner must hold equity equal to at least 50 percent of the value of the property. The equity can be withdrawn as a lump sum, a line of credit or periodic payments. Any funds withdrawn become debts to the lender. However, the debt does not need to be repaid until the borrower dies, moves out permanently or sells the home.

Although there are advantages to reverse mortgages, they can present a problem if the homeowner files for bankruptcy, either in Chapter 7 or in Chapter 13. The main concern of a reverse mortgage borrower in bankruptcy is to achieve the maximum protection available so as to avoid losing the home. A reverse mortgage presents a complication relating to the protection offered by the homestead exemption.

In New Jersey, homeowners filing for Chapter 7 can shield part of the equity in their home from creditors by using the federal homestead exemption. (There is no state exemption.) The federal exemption amount is $27,900 for individuals or $55,800 for married couples. If you have more equity than you can exempt, the bankruptcy trustee assigned to the case would sell the house, give you your amount of exempted equity and distribute the remaining proceeds to creditors.

If you’re a homeowner filing for Chapter 13, you can usually keep your home if you have sufficient disposable income, after meeting your living expenses, to make your monthly payments under the Chapter 13 plan that you agree to. However, an important condition is that as part of the plan, you must pay off the amount of home equity not covered by the homestead exemption.

The availability of the homestead exemption with regard to reverse mortgage funds depends on the extent to which you have accessed them. The unutilized proceeds remain shielded from creditor claims, provided they are less than the maximum exemption. However, once withdrawals have been made under the reverse mortgage, these disbursements will lose their eligibility for coverage by the exemption unless they can be isolated and repaid within a short amount of time.

Another aspect of filing for bankruptcy while you have a reverse mortgage is that that lender will block access to the remaining funds available under the loan. In the worst case scenario, filing for bankruptcy can be considered a breach of contract under the mortgage. This could trigger foreclosure proceedings, although the lender needs to obtain permission from the bankruptcy court in order to proceed.

If you have a reverse mortgage and are facing possible foreclosure, a New Jersey bankruptcy attorney can advise you on your best options for using the bankruptcy laws to protect your property.

The Law Offices of James C. Zimmermann represents clients throughout New Jersey’s Sussex and Passaic counties in Chapter 7 and Chapter 13 bankruptcies. Call us at 973-764-1633 or contact us online to arrange a free consultation.