The Federal Housing Administration has for three decades run the country’s dominant insured reverse mortgage program, and the agency has been relatively easygoing with respect to underwriting. If you qualified on age and equity, you’ve pretty much had a good shot at getting a loan.
But during the years of the recession and mortgage bust, thousands of borrowers fell into default because they didn’t pay their required property taxes and hazard insurance premiums. On top of that, real estate values plunged, producing huge losses on defaulted and foreclosed properties for the FHA. The losses got so severe that the Treasury Department had to provide the FHA with a $1.7 billion bailout in 2013, the first in the agency’s history since its creation in the 1930s.
All of which led to the dramatic changes coming April 27. Applicants are now going to need to demonstrate upfront that they have both the “willingness” and the “capacity” to meet their obligations. Reverse-mortgage lenders are going to pull borrowers’ credit reports from the national credit bureaus, just as they do with other mortgages.
Applicants are going to have to show that they paid their real estate taxes, homeowner association fees and other property-related charges on time for at least the past 24 months. They will be asked to produce documentation of their employment status (if they are still working), income and financial assets, and they will undergo a “residual income” analysis that examines all their monthly expenses and cash flow.
If they get inadequate marks on these tests, they may be required to create a “life expectancy set-aside” — essentially a reserve account or escrow funded wholly or in part from their loan proceeds. For some borrowers, the set-asides may be so substantial they’ll be left with minimal cash at closing, making the entire reverse-mortgage process a waste of effort.
All of which, say experts in the reverse-mortgage industry, will exclude potentially thousands of senior homeowners from obtaining a reverse mortgage, especially those who are on the margins economically and need the cash to help pay for ongoing household expenses.
Reza Jahangiri, chief executive of American Advisors Group, the highest-volume reverse-mortgage lender, told me last week that his Orange, Calif.-based company expects a decline in loan activity by 8 to 10 percent after the financial assessment rules take effect. He also expects a countervailing shift toward “mainstream” borrowers who seek to use a reverse mortgage as part of their overall retirement financial planning, including raising money to purchase a new house or to establish a flexible line of credit they can draw from as needed. Many seniors currently can’t qualify for home-equity credit lines from banks, he said, but with adequate credit, income and assets, they can qualify for a reverse mortgage in the form of a credit line.
Maggie O’Connell, who originates FHA-insured reverse mortgages for the Federal Savings Bank from offices in Reno, Nev., and Danville, Calif., says she has been scrambling to give pre-deadline assistance to people who might encounter difficulty — or be turned off by all the required documentation — under the new rules. Although she may do fewer loans in the short term, she said in an interview, in the long term the tougher rules “are probably all in all a good thing” because they will prevent financially weak borrowers from taking out loans that they can’t handle and that will eventually end up in default, “which is bad for them and bad for us.”
Bottom line: Tougher credit standards have come to reverse mortgages — finally. Before applying, be aware of the types of documentation you’ll need. And when you talk with a lender or financial counselor about a reverse loan, make sure you involve the entire family, so everybody knows what you are getting into.
Ken Harney’s e-mail address is email@example.com.