“The mortgagee must evaluate the mortgagor’s willingness and capacity to timely meet his or her financial obligations and to comply with the mortgage requirements.” – Mortgagee Letter 2014-21
If you have not already heard, the federally insured reverse mortgage program is going through another major change effective March 2, 2015 called Financial Assessment. For the first time, reverse mortgage lenders will be required to assess each borrower’s credit history and monthly residual income. This is a dramatic change for an industry where the focus has been primarily on the value of the home.
Why Financial Assessment?
The first question many will ask is, “why do these things matter when originating a loan that doesn’t require monthly repayment obligations?” After all, the value of the home and the age of the borrower are the primary factors in qualifying. So, why are residual income and credit now included in the underwriting of these loans?
The answer is that these loans should not be viewed as an emergency, short-term access-to-cash, program. Home equity conversion should accomplish more than that. It should always leave the borrower with the ability to pay their property charges and monthly bills. Therefore, we need to document that ability with this assessment. The reverse mortgage MUST be a sustainable solution for the homeowner.
According to Mortgagee Letter 2014-21, “The mortgagee (that is us, the lender) must evaluate the mortgagor’s (that is the borrower’s) willingness and capacity to timely meet his or her financial obligations and to comply with the mortgage requirements.”
The critical borrower obligations and mortgage requirements are as follows:
- Upkeep of the home in good condition
- Payment of property taxes
- Payment of homeowners insurance
- Payment of other property charges (flood insurance, HOA dues, condo dues, etc.)
These are FHA requirements, and we need to document every borrower’s ability to meet these obligations. It is important to note, however, that Financial Assessment is NOT a “yes or no” qualification of the borrower. The results of Financial Assessment are simply used to determine whether a life expectancy set-aside is needed or not.
What is a Life Expectancy Set-Aside (LESA)?
When the underwriter determines that one or more of the financial assessment tests have failed, a Life Expectancy Set-Aside (or LESA) will be required. These are funds that are removed from the borrower’s principal limit and set-aside for the purpose of paying property charges over a calculated time period. The two types of LESAs that may be required are described here:
FULLY-FUNDED LESA – The lender uses funds set-aside from the borrower’s principal limit to pay three critical property charges; property taxes, homeowners insurance, and flood insurance (if needed). The lender pays these charges directly when the bills are due, in the same way a traditional escrow account functions.
PARTIALLY-FUNDED LESA – The lender uses funds set-aside from the borrower’s principal limit to supplement the borrower’s income. This is done to fund a homeowner’s gap in residual income. The lender releases necessary funds to the borrower semi-annually. The borrower, however, will be responsible to pay their own property charges.
For more information on consumer protections and other changes designed to strengthen Home Equity Conversion Mortgages, make sure you purchase the book, Understanding Reverse, and subscribe to my blog in the right-hand margin.