Will Reverse Mortgage Underwriting Disqualify Borrowers With Boarders?

With new underwriting requirements emerging among reverse mortgage lenders that consider a borrower’s income and credit history, a particular segment of the reverse mortgage borrowing population may become ruled out: those who rent rooms or space to family members or others but don’t declare the rental income.

While hard data on the phenomenon is hard to come by, several brokers and lenders told RMD that it’s a common occurrence that they encounter when walking borrowers through the reverse mortgage process. Potential borrowers may receive a portion of their income by housing a tenant, sometimes a person who might help the senior with yard work, errands or house keeping, allowing the senior to stay at home without having to pay for expensive service providers to help out.

“We definitely have see an uptick in interest from homeowners from when the surge began in 2008,” says Rebecca Sheppard, program director for homesharing at St. Ambrose Housing Aid Center in Baltimore. Sheppard also serves as co-president of the National Shared Housing Resource Center. In the Baltimore area where Sheppard is based, the homesharing concept appeals largely to the 50+ female population, Sheppard says. It works for people who don’t need regular medical care, but seek comfort or companionship by living in shared housing rather than alone.

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The program at St. Ambrose will help homeowners with lease agreements and other assistance, but it doesn’t determine whether a homeowner, often a senior, collects rent or claims it.

With respect to these seniors and the new underwriting requirements implemented this month by MetLife and others expected to follow, strict debt-to-income ratios or residual/disposable funds qualifications raise some concern, says Ken Klawans, president of Owings Mills, Maryland-based iReverse Home Loans. “There are many seniors that may not qualify based on those standards, however have either unclaimed income (i.e. boarders, side jobs) or receive family assistance when needed.”

Other originators told RMD the concept of taking in boarders is a common practice they see as well, the concern being that prior to a financial assessment of borrowers, the borrower would qualify for the reverse mortgage and could use it in combination with the rental income toward living expenses, home maintenance and upkeep.

“I have a client that owns a second home that her daughter and son in law live in,” said Jack Belles of Reverse Mortgage of New England. “We cannot document rental income from the daughter to the mother, so you have to count the taxes and insurance on that second property (the property is free and clear) against the ratios of the client.”

The situation is not uncommon among those applying for reverse mortgages.

“It’s a widely publicized trend,” Klawans says.

But lenders in the forward market have responded to home sharing on the flip side, by allowing income from renters as a means to help homeowners out of foreclosure.

“If someone loses thieir job and is looking to do a loan modification, we’re seeing a shift in what lenders will expect,” Sheppard says. “In 2008, most lenders wouldn’t accept a lease as a source of income. Now, lots of them are considering that valid.”

Written by Elizabeth Ecker

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  • Ironic that we’re talking about whether income that seniors dodge taxes on (rental income not claimed on tax return) can be used to qualify for a loan program where substantial risk is borne by the federal government trying to collect said taxes.  If this were just a private reverse mortgage program, maybe there would be more logic in arguing for a different income verification method?

  • The main part of this comment is dedicated to demonstrating the issue and some of its significant difficulties.  I have provided a practice tip at the end of the comment.  I apologize for the length but it is like what I explained to tax staff who came asking “simple questions,” one wishes simple tax questions only had simple answers.
     
    ——————-
     
    The answer to the question in the title is clearly:  NOT NECESSARILY!!
     
    There are many seniors who report all rental income they are required to report to tax authorities.  There are many others who do not.  Some do not because even if they did, they would still not be required to file an income tax return but they could also be ignoring other tax filing requirements. 
     
    Let us say the unmarried out-of-work adult daughter of a widow decides to move back home and help with chores (valued at the value of room and board).  Is any part of that situation taxable?  Or how about the daughter of a close friend who is back in school full-time finishing up a grad degree in Anthropology?  What if it was the underemployed daughter of a third cousin instead but in this case and this case alone, the senior requires that this individual live with her because of fear of falling and not being found for several days? 
     
    (In this paragraph the federal rules will be addressed.)  In the first case there is most likely no income tax rule requiring the reporting of the underlying income by the widow or the daughter because of the legal relationship between the two.  In the latter two cases, the widow has taxable income to report.  The grad student will also have income to report.  The distant relative generally will not have taxable income to report since her employer, the senior, was technically requiring the distant relative to live with her for “the convenience of the employer.”  In all likelihood it would only be in the case of the grad student that there would be any real question about the responsibility of the senior for payroll taxes.
     
    As to state taxes, the situation is based on state law and cannot be addressed since the state, where the senior lives, was negligently left out (writers have at least some privileges).  Not only could state income tax law come into play but so could state payroll taxes and workers’ comp insurance.  It is hard to believe any state tax or insurance laws would apply to the first situation but until one looks….
     
    Most widows who are seniors would probably pay no additional income tax on the latter two situations because of low taxable income.  However, for those to whom it could apply, it could not only increase taxable income by the net rental income includible but it could also raise the portion of Social Security benefits which is taxable; it could also limit some deductions, reduce some income exclusions, and reduce some tax credits.  The federal income tax rules for seniors can get complicated and far more expensive than expected.  BUT there would be no Self-Employment tax for the senior related to any of the situations since all of them involve rental income.  If there is taxable income from rent, some rental expenses might be available related to otherwise nondeductible and even deductible costs such as a proration of out-of-the-pocket expenses like homeowners’ insurance, maintenance, real estate taxes, utilities, interest, etc. and other costs such as  depreciation and amortization.
     
    The situation can get even more complicated in the last two renter situations if the value of the chores is less than the value of the rent in that there may be a gift element involved that in rare cases might have to be reported for gift tax purposes.
     
    The tax rules can get so complicated that many seniors ignore them.  The IRS rarely is aware of such situations and does not seem overly concerned that this is going on since the tax lost in such situations is rarely worth the effort in trying to collect it.  That is not to say the IRS will not attack it when it sees it or finds it; it is to say that it is not high on its priority list of items it is just looking for an excuse to discover (at least that is the situation at THIS time).
     
    PRACTICE TIP
    ——————-
     
    If it could help, seniors can file late original (when an original return for a prior year has not been filed to date) or amended returns to report these items.  If confirmation with the IRS is required, allow for sufficient time for the newly filed tax returns to get processed by the IRS right now that could take as much as a few months.

  • Thank you, Mr. Veale.  Very helpful.  I agree with you that most low-income seniors are likely to just ignore all the complexities and trust that no one will find out or come after them.

    • rmcounselor,
       
      Unfortunately as you are more than aware, ignoring reporting responsibilities can also disqualify prospects for a HECM under the financial assessment underwriting rules of some lenders especially if without it they have insufficient income to qualify.  Just remember whatever is done for federal income tax returns should be done for state income tax return purposes as well and watch out for payroll tax and other related (such as workers’ compensation insurance) issues.  The states generally have different rules which apply.
       

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