In the spring of 2015, the most significant change in the history of Home Equity Conversion Mortgage (HECM) reverse mortgages went into effect. For the first time since the inception of the program, the homeowner’s ability and willingness to manage his/her financial obligations have become part of the qualifying process for a HECM. These and other recent changes have created the New HECM, a significantly different product than its predecessor.
To say this is taking some retirees by surprise is an understatement. According to the TV commercials, lenders were shoveling money at seniors. It looked like “just call us and we will start sending you checks”, but alas that is not the case.
One of the cardinal rules of retirement planning is never transfer risk to the future. It is hard to count the heartbreaking conversations I’ve had with people who have finally decided to set up their HECM, only to find Financial Assessment (FA) changed the rules and they can no longer accomplish what they expected.
For the retiree who has excellent credit and ample income/savings, FA only means some additional application documentation. For people who have experienced or are facing financial challenges, FA can be a game-changer. Explaining FA will be easiest if we break it into segments.
Willingness to pay is demonstrated by your credit history. Do you pay all your bills on time, especially your property taxes and home insurance? If not, could the problem is rooted in a specific even that is understandable which might be a compensating factor? For instance, if everything was fine until a medical crisis, that could be understandable. If the explanation is you that were laid off, but there were late payments before you were laid off, then the story doesn’t work out so well.
Ability to pay speaks to whether your income is adequate for your expenses. Sometimes, this can seem arbitrary. In my rural state of Vermont, there are many people doing very well by heating with their own wood, raising their own food, and making do with considerably less that one might expect. Unfortunately, banking uses systems that are based on anticipated expenses. These can apply even if they don’t feel like they should apply to you.
Lifetime Expectancy Set Aside (LESA) can be a requirement when the lender determines that your willingness and/or ability to handle your obligations don’t meet the standards for the Federal Housing Administration (FHA) insured HECM program. Then the lender calculates the cost of paying your property taxes (and in some cases your home insurance) for you expected lifetime. That amount is held back from the funds available for you to borrow. In the future, the lender uses the Set Aside to pay your property taxes (and possibly your home insurance). In some instances, a modified Set Aside can be created where you pay those expenses instead.
Sad Realities in some cases mean the deal does not work. For example, say you owe $100,000 on a mortgage that is delinquent and the HECM will provide $120,000 for you to borrow. Unfortunately, you need to set up the Lifetime Set-a-Side and that comes to $50,000. That leaves $50,000 to pay off your mortgage and that isn’t enough. So, a HECM would not be able to solve your problem.
Now, we are going to get more complicated with Cash Flow Analysis and Residual Income. Cash Flow Analysis is a way of determining if a borrower has sufficient income to handle his/her obligations and still have enough money to live. A credit report provides information on money owed and required payments. Based on the square footage of the property, other assumptions are made for costs like utilities. When all this is subtracted from the monthly income, what remains is the Residual Income.
The FHA Table of Residual Income by Region is used to establish the minimum remaining money necessary to qualify. For a single person in the Northeast that is $540, while in the West it is $589. If the borrower doesn’t have enough income, a Set-a-Side for property taxes might be a solution, or other compensating factors might come into play. However, there is also the possibility the loan will be denied.
In my rural state of Vermont, clients often argue the table doesn’t reflect their lifestyles. For example, it doesn’t factor the heat source being wood you cut off your land, your food bill being lower because you hunt, fish and garden. Unfortunately, those things are hard to document, may not continue and so cannot be included.
What is the purpose of Financial Assessment? FHA wants lenders to determine whether or not the homeowner is in a sustainable situation and is a reasonable lending risk. Risk is an important consideration because paying one’s property taxes and keeping the home insured are requirements of the loan. Sustainability matters because if a person isn’t really able to afford the house, selling sooner rather than later may be the best choice.
The FA requirements can surprise people. “Why do you need to know about my income?” “What’s this about reviewing my credit history? How do you expect me to prove it? “ Or, I didn’t think you could be denied for a reverse mortgage!” These questions are all part of the greater surprise: the New HECM is like any other application for credit in this country. We have to verify income, analyze your credit history, and be able to demonstrate that you meet the underwriting guidelines for the loan.
That is right: a Home Equity Conversion Mortgage is a loan (even though you don’t have to make payments as long as you live in your house). Like any other loan, there are standards to be met and documentation that must be submitted. You have to provide the necessary paperwork and it needs to meet the loan standards.
So, Financial Assessment is here and that means more paperwork and a more sustainable program. That’s good news for the FHA insurance fund and for the borrowers who are going to be counting on the New HECM as a valid retirement income tool.