Consider a doctor explaining that “A blood vessel wall was damaged, causing a series of reactions to take place which stimulated platelets, resulting in coagulation in your body. You have thrombophlebitis in your lower leg, a condition we call deep vein thrombosis.”
The doctor may be technically correct. But it may be more appropriate to say, “You have a small blood clot, and we’ll give you medicine to dissolve it.”
When you get a traditional loan, the loan officer doesn’t explain all the technical intricacies of residential mortgage underwriting. You simply want to know the rate, the terms, and when you can close.
With reverse mortgages, however, there are additional complex regulations and guidelines that must be covered, including Financial Assessment. Just like the medical profession, there is a big difference between reciting complex industry terminology and a simple explanation of the facts. As someone who generally offers the technical diagnosis, let me try to simplify this time.
Financial Assessment is intended to make sure the reverse mortgage is a sustainable solution for you. The tests aren’t aimed at disqualifying you from a reverse mortgage. They are designed to ensure that, after closing a reverse mortgage, you are likely to have the financial ability to stay in your home.
Financial Assessment Test #1
Lenders are now required to look at your credit history and your property charge payment history. Underwriters call it a “WILLINGNESS” test, but it has little to do with your “desire” to pay bills. Poor payment history simply indicates the need to set aside some funds to make sure critical property charges are paid in the future.
Financial Assessment Test #2
Lenders are also required to look at your monthly residual income. Underwriters call it a “CAPACITY” test. It is designed to ensure that the reverse mortgage product will likely leave you and other household members with the ability to pay your bills now and in the future.
Setting Aside Funds
Each reverse mortgage has a calculated amount called a “Principal Limit”. This is the maximum amount the lender is able to offer a homeowner at the time of closing. The results of Test #1 and Test #2 are used to determine whether a portion of these funds should be set-aside to pay property charges like property taxes and property insurance. The technical name for this is “Life Expectancy Set-Aside” or LESA.
These LESA funds represent a portion of your equity to which you will not have direct access over the life of the loan. However, any unused LESA funds are still part of your equity.
Fortunately, you are not charged interest on the amount that is set aside. When the lender pays your property tax bill, however, your loan balance will rise by that amount.
After spending an hour with a potential client last week, I realized that I didn’t once use technical jargon to describe financial assessment. I was tempted to say something like “based on three 30-day late installment payments in the prior 24 months and a monthly residual income shortfall for a two member household in your geographic region, we need to fully-fund a Life Expectancy Set-aside that will reduce your available net principal limit.”
I would have been technically correct. But when she disclosed information that confirmed that a set-aside would likely be required. I simply said, “Would it give you peace of mind knowing that a portion of your home equity will be set-aside so that the lender can pay your property tax and homeowners insurance each year?”
She and I both agreed it would.