What the reverse mortgage financial assessment means to you
A reverse mortgage now requires 1 or 2 new steps to obtain. The goal is to reduce the number of reverse mortgage borrowers who don't pay property taxes or home insurance.
Steps to determine reverse mortgage eligibility
- Step 1 is an assessment of your finances, and specifically your credit history and income.
- Step 2 is you setting aside part of the mortgage proceeds, based on the results of the financial assessment, to help cover estimated tax and insurance payments over the expected life of the youngest borrower.
Decreasing the default rate
These requirements are the latest in a series of changes intended to decrease the default rate on reverse mortgages. In 2014, about 12% of reverse mortgages were in technical default, says Stephanie Moulton, associate professor at the John Glenn College of Public Affairs at Ohio State University. That is, the borrowers hadn't paid taxes or insurance or both. On top of this, these borrowers had no proceeds remaining from their reverse mortgages.
What's more, the percentage in default had actually increased from 2012, when it stood at 9.4%, according to a report by the Consumer Financial Protection Bureau. More recent information was unavailable.
In comparison, the delinquency rate for single-family residential forward mortgages -- the mortgages most people use to buy homes -- was 10% at the end of 2012 and had fallen to 6.6% two years later, according to the Federal Reserve.
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Ensuring financial stability
Not every reverse mortgage in technical default will proceed to foreclosure, Moulton says. Lenders often work with borrowers to "cure" the default. About half are successful, she says.
Even so, the relatively high rate of technical defaults is a concern. Most reverse mortgages are federally insured through the Department of Housing and Urban Development, or HUD.
"A big question is, are these reverse mortgage borrowers struggling to maintain financial stability?" Moulton asks. After all, reverse mortgages are intended to improve borrowers' financial stability. If this isn't happening, it suggests that modifications to the program may be in order.
A few fixes have been made
Indeed, HUD has implemented a number of changes to its reverse mortgage program over the past few years, such as limiting the portion of loan proceeds that could be disbursed at closing and over the first year of the loan.
The most recent changes -- the requirements for the financial assessment and set-asides -- are in effect for reverse mortgages issued on or after April 27, 2015.
The financial assessment
Each financial assessment includes an analysis of the borrower's credit history, with special attention paid to any foreclosures, defaults, late mortgage payments and late property charge payments.
Research has shown prospective borrowers' credit scores are "huge predictors" of their likelihood to default on reverse mortgages, Moulton says. She is a co-author of the study "An Analysis of Default Risk in the Home Equity Conversion Mortgage (HECM) Program," first issued in 2014 and updated in January 2015. The researchers found that having a prior delinquent mortgage or prior tax lien raised the probability of severe default by 23.4% and 29.7%, respectively. (In the study, "severe default" occurred when a borrower hadn't cured a technical default and owed $2,000 or more.)
In the context of reverse mortgages, the amount of money the homeowner has after paying debts and personal expenses. The lender assesses whether there is enough of this money -- residual income -- to pay for property taxes and insurance.
Part of the assessment is an analysis of the prospective borrower's cash flow and residual income. After all, the borrower still owns the home and will be responsible for paying taxes, insurance and other housing-related expenses. The assessment helps "to ensure someone can maintain the obligations of the loan," says Amy Ford, director of home equity initiatives with the National Council on Aging, which provides counseling to prospective reverse mortgage borrowers.
This analysis looks at income from employment, self-employment, Social Security, alimony, child support, military income, pensions and retirement accounts, among other sources. If the lender determines the borrower isn't willing or able to make tax and insurance payments, then a portion of the mortgage proceeds will be set aside to cover these future costs.