REVERSE MORTGAGES WITHIN THE CONTEXT OF CONSUMER CHAPTER 13 BANKRUPTCY BY OSMARIE NAVARRO MARTINEZ & ALEJANDRO OLIVERAS RIVERA FEBRUARY 2009

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1 BY OSMARIE NAVARRO MARTINEZ & ALEJANDRO OLIVERAS RIVERA FEBRUARY 2009 A BRIEF DESCRIPTION A reverse mortgage is a loan against the borrower s home that does not have to be paid back for as long as the borrower lives the property. The most popular version of this type of loan is known as the Home Equity Conversion Mortgage (HECM). With a reverse mortgage, the borrower turns the value of the home into cash without having to move or to repay the loan in monthly installments. The cash obtained from a reverse mortgage can be paid as a: monthly cash advance; lump sum; credit line account where the borrower decides when and how much of the available cash to use (regular monthly cash advance); or combination of the above payment methods. The proceeds of a reverse mortgage can be used for whatever the borrower deems fit: pay debts, vacation, supplement retirement income, purchase a second property, comply with the chapter 13 plan, etc. The basic requirements to qualify for a reverse mortgage are: home ownership, occupy the property as your principal residence; participate in a consumer information session and be of 62 years of age or older. Borrower is not required to have income, need not be in financial difficulty, or have a good credit history. A borrower may initiate the loan application before attaining age 62, but the loan will not be executed until said age is reached. The cash amounts to be loaned generally, depend on the borrower s age and the home s value: The older the borrower the more he/she can get; and the more the home is worth, the more cash available to the borrower. The lending institution will loan a portion of the equity, not all. The amount will be determined using actuarial tables.

2 Page 2 of 5 After executing a reverse mortgage the borrower has three days within which, if he or she so desires, reconsider the matter and cancel the loan. The three days are business days. Which, include Saturdays, but not Sundays or legal public holidays. A reverse mortgage will be a first rank lien over the property. Thus if there is an existing mortgage loan, it must be paid off. The amount of that existing mortgage loan will also affect the amount of money later available to the borrower under the reverse mortgage. Reverse mortgages become due and payable when the last surviving borrower dies, sells the home, or permanently moves out of the home. If any of the borrowers does not live in the home for 12 consecutive months it is viewed as a permanent move. There are certain other events that may prompt a lender to call in the loan such as, non-payment of property taxes. If borrowers want to make repayments, they can do so. TALC stands for Total Annual Loan Cost and it combines all of a reverse mortgage s costs into an annual average rate. This disclosure is useful when comparing one type of reverse mortgage to another as well as helping in determining the true, total cost of the reverse mortgage under consideration. HYPOTHETICAL BANKRUPTCY CASE SCENARIO John Frommtown is 65 years old, recently retired from a modest paying government job that now provides him with a very small monthly retirement benefit that, coupled to his meager social security monthly benefit, has him pondering bankruptcy since he can barely make ends meet. His main concerns are the mortgage payment over his house, credit card debts and loans taken from family members. John Frommtown decides to make a reverse mortgage to rid him of the monthly mortgage payment, pay down his credit cards and pay in full the $7, loans that he has made to each of his four brothers. Everything now works well for him. He even has a credit line available of $20, which he intends to use when necessary, as a supplement to his retirement and social security income.

3 Page 3 of 5 Then, disaster strikes. A week after executing the reverse mortgage and paying down his credit cards and his four brothers, John Frommtown suffers a massive cardiovascular accident (CVA) that lands him in the hospital for a month. The Hospital bill he receives a week after his discharge almost causes a second CVA. The Hospital demands immediate payment, which John Frommtown cannot even hope on paying now that he will have to tap into his reverse mortgage $20,000 credit line to pay for inhome care. Before a week is over, John Frommtown files Chapter 13 bankruptcy. His very able attorney is now pondering the following questions: 1. Is the reverse mortgage a voidable lien? 2. Does the fact that debtor still has $20, in a credit line have any bearing on how we answer the above question? 3. The payment made to the prior mortgage holder, was it a preferential payment? 4. The payments made to the brothers, were they preferential payments? 5. Are the credit card pay-downs preferential payments? 6. The $20, available in the reverse mortgage credit line, can it be considered disposable income? 7. Is the $20, line of credit personal property to be scheduled in Schedule B or part of the lien to be listed in Schedule D? 8. Will the liquidation value of John Frommtown s estate be determined upon the confirmation of the Chapter 13 plan or, will it be a continuing variable during the course of the case, depending on the reverse mortgage disbursement method chosen by him?

4 Page 4 of 5 9. Does John Frommtown s residence have equity of at least $20, based on the unused line of credit? 10. When John Frommtown is to withdraw from his line of credit, after filing for bankruptcy, to pay for his inhouse care, does he have to apply to the bankruptcy court for authority to incur in secured debt? 11. What about successive months? Not all was bleak for John Frommtown. A week into his bankruptcy, before his attorney had to answer the above questions, John Frommtown won the lottery, dismissed his case and paid the reverse mortgage balance. He cancelled the recordation of the mortgage in the Property Registry. With money on hand and an unquenchable thirst to celebrate life, he flew to Vegas and gambled with the passion of a true believer that he would at least double his fortune. He lost every penny he had. Back from Vegas, broke, with his debilitating ailments, now having just his meager monthly retirement benefit and social security, John Frommtown was reminded by the hospital he still had their debt outstanding, which now stood at $30, This time, the Hospital threatened with collection suit and an attachment of his lien-free house. Although a lousy gambler, John Frommtown had a good memory and recalled his bankruptcy attorney s name and telephone number, proceeding to call her for a second bankruptcy filing. His bright attorney broke the good news immediately. You only have unsecured debt of $30, she told John Frommtown. The bad news is that you don t have enough disposable income to repay it and you have to repay it in full plus interest because of your high liquidation value. Undaunted, John Frommtown looked merrily at his bright young attorney and replied gleefully: Don t let that worry you; we ll do a reverse mortgage in the plan. The plan was crafted so as to make a reverse mortgage within 14 months from the filing date.

5 Page 5 of 5 Once the Chapter 13 Trustee got his hands on the plan, he filed an omnibus objection. Among other things he stated: 1. Since the plan contemplated the incurring of secured debt after confirmation, property of the estate should not revest in the debtor upon confirmation. 2. That the plan should specifically state that prior to incurring the reverse mortgage, Debtor should apply for the Court s authorization. 3. That Debtor s application should be limited in amount to that necessary to satisfy the terms of the plan and incidental costs of the loan application/mortgage. 4. That debtor should still be ordered to answer the questions posed during his first bankruptcy, particularly those related to lien avoidance and preferential payments. You being John Frommtown s bright attorney, what is your reply to the Trustee s objection? Answers received will be tabulated and shared with all. Sources: