There have been two lingering problems with reverse mortgages that have both been recently addressed. I have written about the first before and it is in regards to one spouse being left off of the loan.
The second is the number of people defaulting on a reverse mortgage due to not paying their property charges (insurance, taxes, and association fees). While we don’t have the exact number, we have heard it is potentially greater than one out of every ten customers.
History and Intent
HUD and the industry has collectively decided that it is best to not use a reverse mortgage to delay downsizing if the customer cannot afford the home they live in. If we make a loan to a customer that doesn’t have the income to cover their property charges, particularly once the reverse mortgage proceeds run out, then we shouldn’t make the loan to them in the first place. That customer will eventually default on the loan, and HUD would require the lender to begin the foreclosure process. That isn’t something we want to see happen and brings a lot of negative publicity to the industry.
Now you have an idea why we are having to begin qualifying our customers, much like if you were seeking a conventional refinance or purchase loan. Beginning on April 27, 2015, we will begin a three-part qualification process that includes credit history analysis, a residual income test, and a review of extenuating circumstances or compensating factors. I’ll explain each in more detail below, but the determination will be one of four options: approval with no set-aside for property charges, a partial set-aside for property charges, a full lifetime set-aside for property charges, or declination.
Credit History Analysis
The credit history analysis will be done using a credit report and a review of past payment of property taxes, insurance, and association fees. Some issues that are mentioned include:
- More than two 30-day late payments on mortgages or installment loans in the past 24 months.
- One 90-day late payment or three 60-day late payments on revolving accounts (credit cards) in the past 12 months.
- Collection accounts and/or charge off accounts.
- Delinquent federal debt.
- Chapter 7 (discharge) or Chapter 13 (settlement date) bankruptcy in the past year.
- Late property tax payments or HOA fees in the past two years.
The above issues all have to be explained and an underwriter will need to determine if the credit issue was based on a disregard for financial obligations, an inability to manage debt, or extenuating circumstances. If extenuating circumstances cannot be demonstrated, there will need to be a full lifetime set-aside or the loan will be declined due to lack of funds for a set-aside (in the case of a large mortgage payoff).
Residual Income Test
- Employment income.
- Rental income.
- Disability benefits.
- Pension/retirement benefits.
- Annuity income.
- Department of Veterans Affairs (VA) benefits.
- Social security, disability, workman’s compensation, and public assistance.
- Interest, dividend, and trust income.
- IRA or 401K distributions.
We are able to use assets to increase income, so long as we don’t count them twice. You can either use the interest income or estimated asset dissipation amount (based on your life expectancy). After we have your income, we’ll have to calculate your total monthly debt from your credit report and include an estimation for utilities and maintenance. To determine if your residual income is sufficient to qualify for a reverse mortgage, you’ll want to consult the table below.
|4 or more||$1,066||$1,041||$1,041||$1,160|
Northeast – CT, MA, ME, NH, NJ, NY, PA, RI, VT
Midwest – IA, IL, IN, KS, MI, MN, MO, ND, NE, OH, SD, WI
South – AL, AR, DC, DE, FL, GA, KY, LA, MD, MS, NC, OK, PR, SC, TN, TX, VA, VI, WV
West – AK, AZ, CA, CO, HI, ID, MT, NM, NV, OR, UT, WA, WY
Income from other family members in the home, including non-borrowing spouses, can be used to offset or knock the family size down.
Extenuating Circumstances & Compensating Factors
When a prospective customer fails the credit history review, including a review of past property charge payments, we can consider extenuating circumstances that led to the financial issues. Some examples of extenuating circumstances include:
- Loss of income due to the death or divorce of a spouse.
- Loss of income due to the customer’s or spouse’s unemployment, reduced work hours, emergency medical treatment or hospitalization.
- Increase in financial obligations due to emergency medical treatment or hospitalization, property repairs not covered by insurance, divorce, or other causes that directly resulted in late payments of obligations.
Proper documentation of extenuating circumstances include:
- The connection between the specific occurrence and the measurable impact of the occurrence on the customer’s finances.
- That no other actions taken by the customer contributed to the derogatory credit instance (assuming new financial obligations, voluntarily terminating employment or reducing hours) .
- The likelihood that the circumstances will not recur.
- Demonstrate financial liquidity through other sources of income, assets, or revolving credit lines to endure future financial challenges.
Life Expectancy Set-Aside Calculation
If a customer fails the credit history analysis and cannot demonstrate extenuating circumstances, they will be required to have a full life expectancy set-aside for property charges. The set-aside will be held back from the reverse mortgage proceeds and all property charges will be paid by the mortgage servicer, not the customer. If there aren’t enough loan proceeds for the set-aside, the loan will be declined.
The calculation formula is complex, and it takes into consideration the following:
- Current property charges (taxes, insurance, and association fees).
- Inflation of 20% per year in property charges.
- Life expectancy in years (see tables below).
- Time value of money using the reverse mortgage expected rate & mortgage insurance rate combined (i.e. the line of credit growth rate).
In cases where a customer meets the credit analysis standards, but doesn’t pass the residual income test, a partially funded set-aside will be required. The amount will be based on the shortfall of the customer’s residual income vs. the residual income table above. In these instances, the customer will be responsible for paying the taxes and insurance each year with the help of the set-aside.
Reverse Mortgage Qualification Advice
After reading about reverse mortgage qualification you are probably more confused than before. The good news is that you don’t have to be an expert on the rules. That’s what we’re here for.
It’s important that you find a loan officer willing to do the qualification analysis without having you apply and be counseled first (by a HUD-approved counseling agency). Once we know your income/assets, and have a copy of your credit report in our hands, we should be able to determine your eligibility and set-aside requirements.
You should choose a loan officer that specializes in reverse mortgages and has experience. I can’t emphasize this point enough. I have received countless calls where a customer was misinformed by a loan officer that writes a handful of reverse mortgages every year. It’s not easy to follow multiple industries at one time or learn all of these rules quickly. Would you invest your money with a part-time financial advisor?
If you decide to purchase a reverse mortgage, consider using a reverse mortgage broker to handle your loan application. Mortgage brokers have a bad reputation after the sub-prime fiasco years ago and I’m not sure if it’s deserved. Reverse mortgage brokers can typically offer the loan at similar rates and fees as lenders. The distinct advantage lies in the flexibility we have in taking your application to any of the lenders we work with. There is a lot of subjectively in the qualification rules, so you may be declined by one lender and approved by another. That’s where our expertise can come into play.