Homeowners applying for a reverse mortgage will soon have to clear a new hurdle. In the spring, all borrowers will have to prove that they can handle the ongoing costs of the loan. Homeowners who don't pass the financial assessment could be denied. "It's the biggest change we've ever faced in the industry," says Paul Fiore, executive vice-president of American Advisors Group, a reverse mortgage lender.
The financial assessment is intended to ensure that potential borrowers will have enough money to pay ongoing costs, such as property taxes and homeowners insurance, over the life of the loan. In recent years, the federal government, which backs reverse mortgages, has ended up with about 10% of loans going into default as a result of unpaid taxes and insurance.
A reverse mortgage allows seniors 62 or older to tap their home equity. The loan is not repaid until the homeowner dies, sells the house or moves out for at least 12 months. Nearly all reverse mortgages are insured by the Federal Housing Administration. With the Home Equity Conversion Mortgage, or HECM, the government pays the lender if the house sells for less than the loan balance, so the homeowner will never owe more than what the home is worth.
Previously, reverse mortgage borrowers have not been subject to income and credit checks required of borrowers of traditional mortgages. Reverse mortgage lenders' concerns have focused on the amount of equity in the borrower's home and the home's value.
As the industry grapples with the new guidelines, applicants should expect a slightly longer wait to qualify for and close a loan, at least initially, once the new rules are in place (the expected implementation date was March 2 but that date has been delayed to April 27). "There will be an adjustment period for everyone," Fiore says.
Lenders will have to look at all of the borrower's income streams, such as Social Security and pensions, plus any additional resources, such as investments. Borrowers will have to provide documents such as tax returns and bank account statements.
Any credit trouble will have to be explained. The lender will determine whether the explanation qualifies as an "extenuating circumstance" in getting the loan approved.
The amount of equity in the home can make a difference. "If somebody comes up short in the assessment, but they have equity in the house, that would count as a resource," says Peter Bell, president of the National Reverse Mortgage Lenders Association.
Setting Aside Money for Expenses
The financial assessment determines whether the lender will need to set aside a certain amount of money to pay for property taxes and other expenses over the course of the loan. The "set aside" will reduce the amount of loan proceeds available to the borrower.
To figure whether a set-aside will be required, the lender subtracts property charges, debt obligations and other living expenses from the borrower's income and assets. The resulting "residual income" is the amount of money left over each month. This figure is compared to a government threshold amount (based on region and family size) that determines whether a borrower has enough monthly residual income to pass the assessment. A family of two in Massachusetts must have residual income of at least $906 a month, for instance.
If there is a shortfall in residual income or credit problems, the lender will be required to carve out a set-aside from the loan proceeds. "The older you are, the less you might have to set aside," says Michael Branson, chief executive officer of All Reverse Mortgage Co.
A large shortfall requires a full set-aside that covers all property taxes and insurance over the borrower's life. The lender will pay the expenses from the set-aside.
A small shortfall requires only a partial set-aside. For instance, Bell says if the shortfall is only $100 a month, the amount set aside just needs to cover that $100 monthly difference. The money will be paid to the borrower each month, who then pays the bills.
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