Getting a reverse mortgage is not like the old days. Since 2014, there are more rules, more paperwork, and borrowers must now qualify to get a HECM (Home Equity Conversion Mortgage). These changes were designed to protect seniors and tax payers by reducing defaults. Most people do not understand reverse mortgages; even fewer are aware of these recent changes. Most people who assume that because they have a lot of equity, they can automatically get a reverse. They are surprised and frustrated when they find out that’s no longer the case.
It Used to Be Easy
From the beginning of the FHA reverse mortgage program in 1988 until 2015, borrowers did not have to qualify to get a reverse mortgage. Credit history, late payments, and bankruptcy weren’t an issue. Borrowers did not have to document their income and paying off credit card debt was a normal part of getting a reverse mortgage. For the last thirty years, reverse mortgages were only based on the home’s value and the age of the youngest borrower. That is no longer the case.
Now There Are Rules
The U.S. Department of Housing and Urban Development (HUD) changed the requirements for HECM loans (reverse mortgages) originated on or after 4/27/15. The reason for the change has its roots in the 2009 housing and economic recession. The recession and house price collapse strained the Mutual Mortgage Insurance Fund that supports reverse mortgages. In 2013 Congress passed the Reverse Mortgage Stabilization Act that included, among other things, a requirement that borrowers must pass an income and credit qualification test.
Why Rules Were Implemented
Wade Pfau, Ph.D., CFA, explains that recent changes are designed to ‘ensure reverse mortgages are used responsibly as part of an overall retirement income strategy, rather than to fritter away assets.’ The goal is to reduce the number of foreclosures due to tax and hazard insurance defaults. And to lessen lender and industry reputation risk when a reverse mortgage borrower loses their home in a tax default. Because of heavy losses sustained during the housing crash, reducing FHA insurance fund expenses experienced in a default was a primary mandate.
The new rules include protection for non-borrowing spouse, they limit the amount of money that can be taken out in the first year, and they require a financial assessment to ensure borrowers have sufficient cash flow to pay property taxes, homeowner’s insurance, upkeep and maintenance, and homeowner association dues, if applicable.
Financial Assessment
The purpose of a financial assessment is to evaluate the borrower’s willingness and ability to meet their financial obligations and to comply with all reverse mortgage requirements. The idea of a financial assessment was initially outlined by FHA in 2013. It was put in place in 2014. The government wants to insure reverse mortgages if and only if they represent a long-term sustainable solution.
In the past, people who didn’t have enough cash flow to cover their house and bills could still get a reverse mortgage. It was, however, only a short-term fix and it was easy to see that it wouldn’t end well. While foreclosures on reverse mortgages are rare, they’re expensive and traumatic. They usually occur because someone was not paying their property taxes or the borrowers are gone and others are living in the home. While not the fault of reverse mortgages, these scenarios often lead to bad press for the industry and expenses for tax payers who backstop the FHA mortgage insurance fund.
Financial assessment, in its simplest form, seeks to answer this question: “If you get a reverse mortgage, can you still pay your other property charges and debts on-time, over the long run?” If not, the loan cannot be approved. So, there is both an income and credit dimension to this assessment.
Income
The income consideration asks, “Does the borrower have enough income to cover property charges, open revolving and installment debt, and still have enough left over to live on?” The ‘left over’ amount is called residual income. Here is how it is calculated.
- Property charges
- Property taxes
- Hazard insurance
- Flood insurance (if applicable)
- Maintenance and upkeep (calculated at $0.14/sf of living area)
- HOA, PUD and condominium fees (if applicable)
All other monthly installment and revolving monthly amounts are also included in the calculation. This includes co-signed accounts. Including the monthly payments for co-signed cars and student loans (often for grandkids) sometimes prevent the prospective borrower from qualifying. This happens from time-to-time and it causes enormous frustration, as you might imagine. No one thinks at the time that doing something nice, like helping a grandkid establish credit, might someday backfire and prevent one from getting a reverse mortgage.
In the past, debts could be paid off with loan proceeds. People think they can still do that and not count those monthly payments in the assessment but it doesn’t work that way. Even if the credit cards will be paid off, they must qualify as if they weren’t going to be paid off. One sort of loop hole: if the debts are paid off and accounts are closed prior to loan submission, those previous monthly payments no longer need be considered. And bank statements showing where the money came from to pay off those accounts are not required. Many people say, “If I had enough money laying around to pay off the credit cards, I wouldn’t be carrying a balance.” Fair enough.
Residual Income
The Income calculation is calculated as (Monthly Income – Property – Charges – Debt payments). The amount remaining is called residual income. In the Western United States, the residual income required for an FHA-insured HECM is as follows:
- $589 – family size of 1
- $998 – family size of 2
- $1,031 – family size of 3
- $1,160 – family size of 4+
People are always quick to point out that the ‘residual income’ number isn’t really enough to cover food, medical, transportation, clothing, etc. They have a point but those are the numbers FHA requires to qualify.
Credit
The credit component asks: does the borrower have a history of paying their expenses and obligations on time?” This is determined by reviewing the credit report. Reverse mortgages do not use Fico scores, however, they have several rules on what constitutes satisfactory credit.
- No late property charges in the past 24 months (this includes taxes, insurance, and HOA dues)
- No 30-day lates on house payments or installment debt (car payments and/or student loans) in the last 12 months
- No more than two 30-day lates on mortgage or installment debt in the previous 24 months (months 13-24)
- No major derogatory credit on revolving accounts (credit cards); meaning 3x 60 days late or 1x 90days late
- Bankruptcies must be resolved
The regulations on what can be counted as income, how to handle bankruptcies, federal liens, charge offs, etc., are beyond the scope of this article. They are complicated and navigating them requires more skill than was needed in the past.
There are three possible outcomes from a financial assessment:
The borrowers qualify
The borrowers qualify but must have a tax and insurance set-aside; like an impound account
The borrowers do not qualify
The tax and insurance set-aside aspect is also complicated. It is known as a LESA and the formula is:
LESA = (PC ÷12) × {(1 +c) m+1 ‒ (1 +c)} ÷ {c × (1 +c ) m }
Essentially, it represents the amount of money needed to pay the property taxes and insurance for the ‘expected’ remaining life of the youngest borrower. It is not, however, a guarantee that there will be enough money to pay the taxes and insurance for live. If the borrower lives longer than expected, they will be responsible for coming up with the money to pay all property-related charges.
The bottom line is that reverse mortgages are no longer just based on equity in the home. If the person really can’t afford to keep up with the property charges and their other debt, they cannot get a reverse mortgage.
The financial assessment rules alone are 87 pages long. Loan officers who don’t know what they’re doing can hurt borrowers by: 1) offering false hope for a solution that isn’t available; 2) wasting their time; and 3) wasting borrowers’ money on counseling (approximately $150) and an appraisal (approximately $500).
Article Reposted by permission
Special Thanks to Kent Kopen, Certified Reverse Mortgage Professional
Don Graves, RICP®, CLTC®, Certified Senior Advisor, CSA®
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