Many still claim reverse mortgages do not require income, and prior to 2015 they would have been correct. That changed when HUD began requiring every lender to examine the financial capacity of the borrower and the sustainability of each HECM loan. Residual income analysis can be summarized using the following 3-step process:
1. Calculate effective monthly income
The underwriter will calculate monthly income, including social security benefits and employment income that is likely to continue for three years. The underwriter may also consider pension, IRA, 401(k), rental, disability, annuities, and many more sources of income or cash flow. Even assets may be counted as income. This is called imputed income or dissipation. In this context, “dissipate” means to spread the after-tax value of the asset over the youngest borrower’s remaining life expectancy.
2. Subtract monthly expenses
The underwriter will then consider monthly debt obligations from the credit report as well as a monthly calculation of property charges for all owned real estate, including but not limited to, property taxes, homeowner (hazard) insurance, and Homeowner Association (HOA) dues. The underwriter will also estimate maintenance and utility charges by multiplying the square footage of the subject property by 14 cents.
3. Compare the residual income to HUD’s requirements
HUD requires that residual income be sufficient to pay for items that cannot be documented with a credit report. Those household costs tend to vary by region and family size. Therefore, the underwriter will use the following charts to determine the required threshold:
Required Residual Income by Region and Family Size
States by Region
If it does not appear that there is sufficient residual income, there are several compensating factors that an underwriter may consider. In addition, family size may be reduced if an underwriter wishes to document the income and credit history for a non-borrowing household member that has the financial capacity to carry their own weight.
If the residual income is still not sufficient, a portion of the principal limit may be earmarked for paying property charges. This is accomplished by using a Life Expectancy Set-Aside (LESA).
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