Mortgage Professor: No ‘Deadbeats’ Under New Reverse Mortgage Rules

The upcoming financial assessment will make reverse mortgage borrowers have to prove they’re not “deadbeats,” writes The Mortgage Professor in a recent article, noting that the new rules are also tougher in some ways on those seeking a reverse mortgage than a standard mortgage.

While the income and credit requirement on reverse mortgage applicants — to be imposed March 2 — should reduce the default rate on new loans, the downside is that future borrowers “will have to pay the higher costs of originating and servicing HECMs, and wait longer for deals to be completed,” says The Mortgage Professor, a.k.a. Jack Guttentag.

Nearly a year after the Department of Housing and Urban Development (HUD) delayed its implementation of the financial assessment for the Home Equity Conversion Mortgage (HECM) program, HUD released its final time frame and guidance for implementation late last year.

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In some ways, the new underwriting requirements that lenders will apply to all applicants are tougher than those used with standard mortgages, Guttentag says.

“This is strange, considering that applicants for reverse mortgages pay only taxes and insurance whereas applicants for standard mortgages also pay principal and interest, which is usually much larger,” he says. “On the other hand, the applicant for a standard mortgage who fails to meet the underwriting criteria is rejected whereas the applicant for a reverse mortgage who fails the test has another option, called a Fully-Funded Life Expectancy Set-Aside.”

The Set-Aside is an amount drawn under the HECM that is reserved for payment of property taxes and insurance by the lender, and is viewed as sufficient to assure the required payments can be met through the entire lifespan of the borrower.

“I calculated the required Set-Aside for a borrower of 75 with life expectancy of 144 months, taxes and insurance charges of $5,000 a year, and interest rate plus mortgage insurance premium of 5%,” he says. “It was $54,000, not a trivial sum.  If this borrower had equity in his home of only $100,000, the Set-Aside would use virtually all of it, and no additional funds could be drawn. If his equity was less, the required Set-Aside would not be possible and he would be rejected.”

Another option is the Partially-Funded Life Expectancy Set-Aside, which is available to applicants who meet the credit requirements and are therefore viewed as willing to meet their obligations, but don’t have enough income.

The new rules have two “remediable weaknesses:” new underwriting requirements must be applied to every applicant, and lenders must make the required payments under the fully-funded Set-Aside, he says.

Regarding the first, he says, “[…] applicants with plenty of equity in their homes might find that the fully-funded Set-Aside imposes no burden on them at all, in which case the underwriting costs could be avoided. There is no reason why lenders and borrowers should not have that option.”

In addition, borrowers should have the option of making the required payments with their own funds, with the inducement that an equivalent amount will be transferred from the Set-Aside account to the borrower’s credit line, he says.

“The purpose is to encourage borrowers to become responsible,” he says. “This would involve no risk to FHA, since the lender will make the payments if the borrower doesn’t.”

Read the article here.

Written by Cassandra Dowell

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  • Deadbeats — what a ridiculous name to put into the title of an article which describes the plight of many seniors during the financial crisis of almost a decade. While I respect Dr. Guttentag, the use of this name in this context is hardly commendable.

    The discount rate Dr. Guttentag uses of 5% means the expected interest rate is just 3.75%. If the expected interest rate is raised to 4.5% in his example, the discount rate would be 5.75%, and the Fully Funded LESA he uses in his example would be about $2,100 less (using a more exact amount for the results of both). The Fully Funded LESA in this case would be about 72% of what the total payments are assumed to be at $72,000 (or $5,000 times the 1.2 factor times 12 years).

    Like the principal limit computation, the higher the interest rate, the lower LESA but the opposite of the principal limit computation, the older the senior, the lower the LESA. Obviously the lower the property charges, the lower the Fully Funded LESA will be. So be careful when describing a LESA computation since in some ways it works exactly like the Principal Limit computation but then again the impact of the age of the youngest borrower is just the opposite than in the principal limit computation.

    [If calculating the amount without the benefit of a HECM calculation remember to use the beginning of the period (not the end of the period) option.

    It makes sense to use the life expectancy of the youngest borrower but only if the life expectancy is less than 150% (or better 120%) of the average life of a HECM. Thus for HECMs where the youngest borrower is under 76, the set aside capitalization period would be 12 years (150% of the average of a HECM currently about 8 years) rather than going all the way to 21 years for someone 62 years old like the LESA computation is now.

    While it is unclear why a 20% flat increase would apply to property charges (and monthly residual income shortfalls) no matter what the period being capitalized, it would seem that the increase factor would be much different for a loan with a life span of 3 years than one for 21 years, yet the increase factor is identical for all. If the rate was 2% annually and using a maximum capitalization period of 12 years, the average increase rate for a 95 year old (and older) would be 3.6% when compounded monthly while for those 76 and younger it would be 13.5% with other age borrowers in between.

    The suggestions in these bracketed paragraphs is to suggest less draconian factors for use in LESA computations. The goal is not flawless default prevention computations but rather to make sensible set asides to allow borrowers to make other living arrangements or to sell the home if necessary over a reasonable period of time which is less likely than previously to result in “a fire sale” or market condition low price when the inability to pay property charges is other than temporary. Some even suggest that the maximum set aside period should be no more than 8 years which again seems sensible.]

    (The opinions expressed in this comment are not necessarily those of RMS or its affiliates.)

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