Eminent Domain: What Happens to a Home with a Reverse Mortgage?

The right of eminent domain is used by a government entity when a home or other property is seized to make way for a public project like a new road, bridge, or school.

The takings clause of the Fifth Amendment to the U.S. Constitution requires that the owner must be justly compensated for the loss. Courts have held that to mean that the property owner must 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.

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. It may not seem fair to the owners of the property, and eminent domain legal cases—especially when the owners feel that they have not been justly compensated—are fairly common.

Eminent Domain and the Reverse Mortgage

The compensation payment, when combined with the equity in the home, may be enough to pay for a new home or at least provide for a down payment on a new mortgage. But if the homeowner has a reverse mortgage, then 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. 

The chances may be more favorable if the homeowner has significant equity in the property. The home may have increased in value since the reverse mortgage was obtained, or the homeowner may have maintained significant equity in the home by borrowing only a limited amount.

The worst-case scenario occurs when the homeowner has taken a substantial amount of the property value in reverse mortgage payments and has not had enough time (or enough luck) to enjoy a substantial increase in the property’s value. In such cases, the government payment may fall well short of the cost of replacement.

Home Value

The problem arises 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 case in 2012, an Oregon homeowner was offered just enough money to repay her reverse mortgage when the state’s Department of Transportation needed her home for a road project. The state agency eventually agreed to let the woman, then in her mid-80s, live in an agency-owned home rent-free for as long as she needed it.

In a time of rapid home appreciation, such situations are less likely. A home’s value is likely to exceed the amount borrowed years before, notes David Henson, managing partner of Henson Fuerst of Raleigh, N.C., a specialist in eminent domain and related property law.

However, downward swings do happen in housing markets. 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 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.”

Many homeowners in such a situation face added costs, such as appraisal fees and relocation expenses, which are not necessarily covered in eminent domain cases. 

As in traditional forward mortgages, the language of the relevant loan agreement is crucial. It should spell out what happens in case of a condemnation of the property. It should also state that the proceeds are to go to the homeowner, although the lender will have to approve the ultimate arrangement.

The Bottom Line

An eminent domain condemnation can severely complicate the financial and housing situations of homeowners using a reverse mortgage, particularly if a large proportion of the home’s equity has been withdrawn.