When a homeowner applies for a “forward” mortgage, the lender will want to check their credit to make sure the borrowers have good credit scores. They will also check their income to make sure they can afford the payment.
The Home Equity Conversion Mortgage (HECM), which is the name for the FHA reverse mortgage program, began in 1989. For the first 26 years of the program, homeowners could obtain a HECM reverse mortgage without worrying if their credit was good enough or if they had enough income. After all, there are no monthly payments required when with a reverse mortgage.
However, that all changed in 2015. The Department of Housing and Urban Development (HUD), issued new rules to reverse mortgage lenders requiring them to evaluate the borrower’s “willingness (credit history) and capacity (income) to timely meet his or her financial obligations and to comply with the mortgage obligations.” This is called Financial Assessment (FA).
The reason for the change is that even though there are no payments required with reverse mortgage loans, the homeowners still have ownership obligations. If they fail to meet these obligations, they could be foreclosed upon and lose their home.
The requirements of the loan are:
- Pay property taxes on time.
- Pay homeowner insurance on time.
- Pay flood insurance if required.
- Keep the home in good repair.
- Pay all other applicable property charges (HOA dues for example).
The bottom-line reason for this change is that everyone involved with reverse mortgages from the lenders to the borrowers to HUD want it to be a sustainable solution. Ideally, reverse mortgages should leave the borrowers in a better financial situation than before the loan. This means they must have the ability to pay their property charges and monthly bills now and in the future.
While HUD requires lenders to document a homeowner’s ability to meet these obligations, the result of the financial assessment doesn’t necessarily lead to a “yes or no” answer.
If a borrower does not meet the FA standards, they may still be able to receive a reverse mortgage. The lender will have to set aside a portion of the money from the reverse mortgage to pay the property charges on the borrower’s behalf.
This is called a “Life Expectancy Set-Aside” (LESA).
The LESA works like an escrow account that forward mortgages use. However, since the borrower is not making payments, the lender has to take part of the money they would loan (called Principal Limit), and set it aside to cover the property charges for a set number of years depending upon the youngest homeowner’s age.
While the LESA may reduce a borrower’s proceeds, it’s not necessarily a bad thing to have a LESA. It can provide the peace of mind knowing that critical property charges will be taken care of.
One last bonus of this process is that the interest rate a borrower is charged is not based on them passing the financial assessment. Just because the borrower does not have perfect credit or may not have as much income as other borrowers, they might need a LESA, but the interest rate will be the same as other borrowers who do qualify.
Please feel free to contact me if you have any questions.
Bruce E. Simmons, CRMP