The main question we are asked is why does a loan, with no required monthly repayment of principal and interest, require you to qualify for it? Or I thought reverse mortgages do not require any kind of qualification? Historically, ten to fifteen percent of borrowers were defaulting on their property charges (taxes, insurance, or HOA dues), which is considered a default on the loan. Defaults, if left unresolved, lead to foreclosure, so HUD decided to address the issue. Lenders have since copied these rules over to their proprietary offerings, so there is no evading them when taking out a reverse mortgage.
History and Intent
HUD and the industry 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. On April 27, 2015, we were required to start a three-part qualification process that includes credit history analysis, a residual income test, and a review of your property charge payment history. We will 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 life expectancy set-aside for property charges, or declination.
Credit History Analysis
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 life expectancy set-aside or the loan will be declined due to lack of funds for the set-aside (in the case of a large mortgage payoff).
When a prospective customer fails the credit history review, we can consider extenuating circumstances that led to the financial issues. Some examples of extenuating circumstances include:
- Death or divorce of a spouse
- Terminated or laid off from employment
- Emergency medical treatment or hospitalization
- Other obvious one-time events that were outside of your control
- 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
Proper documentation of extenuating circumstances include:
Residual Income Test
The residual income test or cash flow test is used to determine if you are able to meet your documented financial obligations. The idea is that you need to have the income to cover your property charges and liabilities on your credit report, leaving you with enough residual or net income to survive. The sources of income for this test often include one or several of the following:
- Social security income
- Pension/retirement benefits
- Employment income
- Rental income (must be on tax returns)
- Disability benefits
- Annuity income
- Department of Veterans Affairs (VA) benefits
- Interest, dividend, and trust income
- IRA or 401K accounts
For retirement assets, we use an estimated asset dissipation amount (account balance divided by 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.
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.
Property Charge Payment History
The property charge payment history is a two-year lookback from the time of application for the reverse mortgage. This is for any property owned by a borrower in the past 24 months, even if you do not own it currently. We are required to verify the following:
- Property taxes
- Homeowner’s association dues, if applicable
- Homeowner’s insurance (only a 12-month history)
Any payments made over thirty days late are treated just like a 30-day late on a mortgage. Typically one-offs can be explained, but a history of paying property taxes or association dues late, or letting them be over 30 days late is a larger problem and can force a life expectancy set-aside.
Life Expectancy Set-Aside (LESA)
If you fail the credit history analysis, or property charge payment history, and cannot demonstrate extenuating circumstances, you will be required to have a 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 until the funds run out. If there aren’t enough loan proceeds for the set-aside, the loan will be declined. Consider the set-aside to be like a prepaid escrow account, but from loan proceeds.
The calculation formula is complex, and it takes into consideration the following:
- Current property charges (taxes & any insurance including flood)
- 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)
- Given the above, you cannot just multiply your life expectancy by your property charges
Now that we have recapped the three qualification tests, lets go over what passing and failing them ultimately means. If you pass them all, you are offered the loan with no set-aside, unless you voluntary elect to have one.
If you do not pass the credit or property charge payment history analysis, you will be required to have a life-expectancy set-aside that is based on your age and property charges. If you do not have enough loan proceeds to cover the set-aside, and you do not have cash to bring to the closing table, your loan will be declined.
If you do not pass the residual income test, you will not be able to take out the loan. There are some exceptions when you get to 80% of the residual income needed, but for the most part you have to have enough income to survive in your home, even after exhausting the reverse mortgage proceeds.
Reverse Mortgage Qualification Advice
After reading about reverse mortgage qualification you are probably more confused than before. The good news is that you do not have to be an expert on the rules. That’s what we are here for, as there is a lot of nuance to these complicated rules that you only know after working on hundreds of scenarios.
It’s important that you find a loan officer willing to do the qualification analysis without having you apply and be counseled first (because it costs money to do the counseling). 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 who specializes in reverse mortgages and has experience.
We cannot emphasize this point enough.
We have received countless calls where a customer was misinformed by a loan officer who writes a handful of reverse mortgages every year. There are ways to work within the rules and be creative to help people qualify and we excel at that.