Mortgage: What reverse mortgage financial assessment means to you
Karen M. Kroll
Sep. 16, 2016
A recent change added two steps to the process of obtaining a reverse mortgage. The goal is to reduce defaults on reverse mortgage by making certain that borrowers can pay property taxes or home insurance.
Steps to determine reverse mortgage eligibility are:
Do an assessment of your finances; specifically your credit history and income.
Set aside part of the mortgage proceeds, based on the results of the financial assessment, to help cover estimated tax and insurance payments over the expected life of the youngest borrower.
These requirements are the latest in a series of changes intended to decrease the default rate on reverse mortgages. In 2014, about 12 percent of reverse mortgages were in technical default, said Stephanie Moulton, associate professor at the John Glenn College of Public Affairs at Ohio State University. That is, borrowers hadn't paid taxes or insurance or both. On top of this, borrowers had no proceeds remaining from their reverse mortgages.
A July 2016 study from the Center for Retirement Research at Boston College concluded that the new rules could cut the reverse mortgage default rate by as much as half.
Not every reverse mortgage in technical default will proceed to foreclosure, Moulton said. Lenders often work with borrowers to "cure" the default. About half are successful, she said.
Even so, the relatively high rate of technical defaults is a concern. Most reverse mortgages are federally insured through the Department of Housing and Urban Development, or HUD.
"Are these reverse mortgage borrowers struggling to maintain financial stability?" Moulton said. After all, reverse mortgages are intended to improve borrowers' financial stability.
HUD has implemented a number of changes intended to improve and strengthen its reverse mortgage program during the past few years, such as limiting the portion of loan proceeds that could be disbursed at closing and over the first year of the loan.
The changes requiring the financial assessment and set-asides cover reverse mortgages issued on or after April 27, 2015.
Each financial assessment includes an analysis of the borrower's credit history, with special attention given to any foreclosures, defaults, late mortgage payments and late payments for property charges.
Research has shown prospective borrowers' credit scores are "huge predictors" of their likelihood to default on reverse mortgages, Moulton said.
What is residual income? It is the amount of money a homeowner has after paying debts and personal expenses. The lender assesses whether there is enough of this money - residual income - to pay for property taxes and insurance.
Part of the assessment is an analysis of a borrower's cash flow and residual income, since the borrower still owns the home and will be responsible for paying taxes, insurance and other housing-related expenses. The assessment helps "ensure someone can maintain the obligations of the loan," said Amy Ford, director of home equity initiatives with the National Council on Aging, which provides counseling to prospective reverse mortgage borrowers.
This analysis looks at income from employment, self-employment, Social Security, alimony, child support, military income, pensions and retirement accounts, among other sources. If the lender determines the borrower isn't willing or able to make tax and insurance payments, then a portion of the mortgage proceeds will be set aside to cover these future costs.
Calculating the life-expectancy set-aside requires estimating how much the cumulative property taxes and insurance will cost during the life of the youngest borrower. Property and flood insurance premiums are included.
The sum could be large enough that the reverse mortgage no longer makes sense, said Richard Wills, CEO at Retirement Life Funding in Silver Spring, Maryland.
Say a homeowner's property taxes average $2,000 per year, and he or she is expected to live another 20 years. That could mean setting aside at least $40,000 from the proceeds of the reverse mortgage - and that's before adjusting for any increases. In the end, it may no longer be a viable funding option.
If the borrower has a clean credit history but doesn't have enough income to make tax and insurance payments, it may be possible to do what's known as a partially funded set-aside. Still, the changes in the rules mean an estimated 10 percent - 25 percent of potential borrowers no longer will qualify for reverse mortgages, Wills said.
However, the regulations aren't much different from the underwriting requirements in place for traditional mortgages, said Peter Bell, president of the National Reverse Mortgage Lenders Association. The goal "is to avoid making loans to borrowers who have a high likelihood of failing."
If a reverse mortgage isn't available, there could be other options to help seniors improve their financial footing. Some cities reduce property taxes for seniors, the National Council on Aging's Ford said.
In some families, a parent could sell the home to an adult child, who then would rent it back to the parent, said Bradley J. Frigon, an attorney in the Denver area and past president of the National Academy of Elder Law Attorneys.
Even for individuals still able to obtain reverse mortgages, the financial assessment and set-aside requirements likely will lengthen the time between application and settlement, Wills said.
But conducting a financial analysis of prospective borrowers and requiring set-asides for those at higher risk of default are steps many have said were needed, Moulton said.