Eminent domain is used when a home or other property is condemned for a new road, bridge, school or another public use by a government entity: The takings clause of the Fifth Amendment to the United States Constitution spells out that the owner is to be justly compensated. Courts have held that to mean the property owner is to be paid the fair market value of the property.
In a typical mortgage, the amount may be enough to pay for a new home, because the homeowner’s equity increases as they make mortgage payments. However, the situation might be somewhat different if the homeowner has taken out a reverse mortgage.
- Eminent domain cases on reverse-mortgaged properties are rare, but they can happen and can cause complications for borrowers.
- Unlike in traditional forward mortgages, a homeowner’s equity decreases in reverse mortgages, potentially leaving little more than what is needed to repay the loan and not enough for a new home, even if fair market value is received for the condemned property.
- The proportion of the home’s value is borrowed against and whether values are appreciating in a particular home market are two critical factors.
How Eminent Domain Works
Eminent domain is the power of a government, whether federal, state or municipal, to take private property for public use, following the payment of just compensation. This practice occurs in many different countries under different names and is not only a concept in the United States. It may not seem fair to the owners of the property, and eminent domain cases, especially when the owner feels they are not justly compensated, are fairly common.
Eminent Domain and Reverse Mortgage
The compensation payment, when combined with the equity, may be enough to pay for a new home or at least provide for a downpayment on a new mortgage. But in a reverse mortgage, the homeowner may not have enough remaining equity in the home to pay off the loan and buy a new residence using the compensation payment.
If the home has increased in value since the reverse mortgage was established, there may be enough funds left to buy a new home. Similarly, if the homeowner has maintained significant equity in the home by borrowing only a limited amount, there may be sufficient funds to buy a new home or otherwise pay for housing. To help ensure these outcomes, financial advisors and retirement planners recommend using a reverse mortgage only as part of an overall financial program.
Homeowners may face added costs, such as for appraisals and relocation, which are not necessarily covered in all eminent domain cases.
Problems arise when the amount borrowed leaves the homeowner with little equity in the property and thus little actual cash from the settlement with the condemning authority. In a publicized case from Oregon in 2012, the amount the homeowner was offered by the state’s Department of Transportation for property needed for a road project would go entirely to her lender to repay the reverse mortgage. The state agency eventually agreed to let the woman, then in her mid-80s, live in a home the agency owned rent-free for as long as she needed it.
In a period of rapid home appreciation in nearly all housing markets, such situations may be unlikely, as a home’s value is likely to exceed the amount borrowed, notes David Henson, managing partner of Henson and Fuerst of Raleigh, North Carolina, a specialist in eminent domain and related property law. However, downward market swings do happen, Henson says. Further, while the law varies among states, condemning authorities and the courts are not likely to consider the homeowner’s debt.
Property Value Vs. Debt
“The relevant factor truly is what’s the value of the property before they take it, what’s the value of the property, and what are the damages that result,” Henson says. “The debt is immaterial as to how the damages are either negotiated or tried if it goes in front of a jury.”
In addition, homeowners may face added costs, such as for appraisals and relocation, which are not necessarily covered in all eminent domain cases.
As in traditional forward mortgages, the language of the relevant loan agreement is crucial. It should spell out what happens in a condemnation. Also, Henson noted, that typically the proceeds are to go to the homeowner, but the lender will usually have to approve the ultimate arrangement.
How Does Eminent Domain Work?
Eminent domain is the process by which a government, either local, state or federal, may acquire property deemed needed for the public good. Part of the Fifth Amendment to the United States Constitution requires owners of such property be justly compensated, which generally is held to mean paid fair market value.
How Does an Eminent Domain Proceeding Affect a Reverse Mortgage?
The impact is largely the same as on a traditional, or forward, mortgage. That is, the government pays the property owner, who then will have to pay any outstanding balance on the home loan. The owner is more likely to be able to replace the home because of the equity, or ownership stake, in the property. In a reverse mortgage, however, equity diminishes by the amount borrowed plus interest and any other repayment costs. If the homeowner has little equity left, they will get only a limited amount of money, which may not be enough to buy a replacement home.
How Can I Protect My Property From Eminent Domain?
Unfortunately, there is not much you can do to protect your property from eminent domain. It is not always real estate that is seized, and it is not possible to anticipate the future needs of the public or the government. It may seem unfair, but property owners do not have many options to protect their property from seizure by the government.
The Bottom Line
An eminent domain condemnation can severely complicate the financial and housing situation of homeowners using a reverse mortgage, particularly if a large proportion of the home’s equity has been withdrawn.