Borrowers can choose from three classes of reverse mortgages: single purpose, jumbo or proprietary and the FHA's Home Equity Conversion Mortgage (HECM). Each type dictates its own set of eligibility requirements, rules and guidelines. HECMs account for 90 percent of reverse mortgages in the U.S., as most reverse mortgage borrowers choose an FHA reverse mortgage.
The HECM is the only reverse mortgage with standard guidelines. The federal government, through the Department of Housing and Urban Development (HUD), issues and sets HECM requirements and rules lenders must follow.
HUD sets specific borrower eligibility requirements:
- Be at least 62 years old.
- Can't be delinquent on federal debt.
- Complete reverse mortgage counseling from HUD-approved providers.
- Occupy the home as primary residence.
- Pay taxes and insurance and maintain the property to avoid foreclosure.
- Pass a financial assessment or allow the lender to withhold some loan proceeds for property-related expenses.
- Own home free and clear or pay off existing mortgage with the HECM proceeds.
- Pay mortgage insurance premiums.
- List spouse, if any, in mortgage documents if the spouse lives in the home even if spouse is not a co-borrower or co-owner.
HUD also defines property requirements for HECM loans:
- Maximum loan amount based on the property value or $625,500, whichever is lower
- Borrower can use an HECM to buy a new property (see HECM for Purchase Program section).
- Must be single-family residence, condominium, two-to-four unit property (in which one unit is occupied by the borrower) or FHA-approved manufactured home
- Property must be in decent repair and, if not, lender may require repairs before closing
HUD issues additional rules pertaining to the loan amount and transaction costs:
- Maximum loan amount depends on the property value, borrower's age and interest rate.
- Borrower can choose a fixed or adjustable interest rate, although a fixed rate applies only to lump sum distribution, which is limited by a maximum loan amount that is 40 percent lower.
- Payout distribution can be a lump sum, monthly payments for a limited term, monthly payments for life, a line of credit or a combination of payout methods.
- Maximum payout is determined by the age of the younger spouse — even if the spouse is not obligated by the loan — to prevent younger spouses from being evicted from their homes if the older spouse predeceases them.
- Only required fee is mortgage insurance premium.
- Origination and servicing fees are capped by the government.
Single-Purpose Reverse Mortgage
The governments or organizations offering single-purpose reverse mortgages set the requirements. Single-purpose loans come in two flavors:
Deferred Payment Loan (DPL)
You can use the DPL to pay for property repairs that are necessary to alleviate health and safety concerns. It usually carries a very low interest rate (sometimes even zero percent) and need not be repaid until you vacate the property.
The Property Tax Deferral (PTD)
You can use the PTD, offered by state and local governments, to pay property taxes. Only senior citizens with low or very low incomes have access to the DPL or PTD.
If you have trouble keeping up with home-related costs and you're eligible for either a deferred payment loan or property tax deferral, you should apply for the reverse mortgage as quickly as possible because these programs tend to run out of money quickly. Your best bet is to contact local housing authorities to locate single-purpose programs. You can find many single-purpose loan programs on HUD's state resource pages.
Jumbo or Proprietary Reverse Mortgage
Jumbo reverse mortgages need not comply with HECM guidelines. Instead, the lenders that offer jumbo reverse mortgages set their own requirements, which vary from one lender to the next. However, you can expect jumbo or proprietary reverse mortgages to carry fewer restrictions, which can work for or against you. Because the restrictions and requirements are lender-specific, you must carefully evaluate each prospective lender to see a complete picture of its reverse mortgage loan. Be wary of making automatic assumptions about a reverse mortgage. Be fully aware of a reverse mortgage's requirements, restrictions, fees and costs before you commit to paying for an appraisal or other fee.
Borrower requirements for jumbo reverse mortgages are hard to pin down. The requirements tend to be looser than HUD's HECM requirements:
- Fewer age-related restrictions.
- Income and credit score may not be a factor.
- Higher maximum loan amount (younger spouse's age, a factor that lowers a HECM's maximum loan amount, is irrelevant if spouse opts out).
- No counseling requirement.
- Obligation to pay taxes and insurance and maintain the home to avoid foreclosure.
Property types and restrictions vary among lenders:
- Acceptable types determined by individual lender.
- Acceptable uses determined by individual lender.
- Properties with higher home values can be financed (qualified homeowners can borrow more than $2 million).
Lack of government regulation translates to greater variation in fees and costs. The government caps fees for HECM but you'll find no such cap in place for jumbo reverse mortgages. In some cases, higher fees apply, so closely track the costs of a jumbo reverse mortgage. Fortunately, jumbo reverse mortgage lenders are required to deliver the same TALC, GFE and TIL disclosures that HECM lenders provide.
HECM for Purchase Program
If your goal is to purchase a home with HECM funds, the government has already set up a program for borrowers just like you — the HECM for Purchase program. The program's requirements differ slightly from a regular HECM. Once you get started, you'll notice the financial assessment your lender conducts is more stringent. Your lender, in addition to complying with the financial assessment requirements of a regular HECM, will impose additional rules for the following conditions:
HECM for Purchase Requirements
If you plan to borrow funds for the down payment of your new home, you may be out of luck. HUD won't allow you to borrow money for the down payment.
If you have insufficient reported credit history, your lender will check your non-traditional credit, such as verification of utility payments and other accounts that don't necessarily report to credit bureaus.
Chapter 7 Bankruptcy
Two years must lapse from the discharge date of a Chapter 7 bankruptcy. In the period following the discharge, you must re-establish credit or refrain from using credit. However, if your original filing was the result of a factor out of your control your lender can reduce the two-year requirement to one year.
Chapter 13 Bankruptcy
You must be at least 12 months into your repayment plan to be eligible for a HECM purchase loan. You must have a record of timely payments in the plan and obtain written permission from the bankruptcy court to enter into the HECM transaction.
HECM for Purchase Rules
Understanding the purpose of a HECM for Purchase loan is the first step toward grasping how the program operates. The HECM for Purchase program allows homeowners to use less of their savings to simultaneously accomplish two objectives: downsize and maximize the amount of cash in their nest egg.
Here's an example that illustrates the utility and flexibility of the program
Mr. and Mrs. Evans want to sell their large family home and move to a less expensive dwelling. They find a willing buyer and sell the property for $400,000; after paying off their mortgage balance and taking care of closing costs, they net about $300,000. In addition to the proceeds from the sale, they have another $100,000 in an individual retirement fund, giving them a total savings of $400,000.
The couple locates a new home with a price tag of $300,000. With sufficient savings, the Evans couple could purchase it outright with cash and still have $100,000 left over in savings. They'll have no mortgage payment obligation, but they'll also have little cash in reserve. They decide they would feel more comfortable with a larger financial cushion. What are their options?
The cheapest route would be to finance the new home purchase with a traditional mortgage, making a substantial down payment and getting a loan for the rest. However, both Mr. and Mrs. Evans strongly dislike the notion of making monthly mortgage payments, a requirement of all traditional mortgages. They are retirees and don't want that financial obligation.
That's where the HECM for Purchase loan comes in. They decide to purchase the $300,000 home by putting $150,000 down, which is 50 percent of the sales price, and financing the rest of the purchase with an HECM purchase. The result of this strategy? They keep $250,000 in the bank and have a new place to call home with no monthly mortgage payment obligation hanging over their heads. They can continue to enjoy retirement.
HECM Financial Assessment
A HECM financial assessment of a borrower differs from ordinary credit and income underwriting of traditional forward mortgages. Your lender's goal in conducting the financial assessment is to confirm that it can rely on you to act responsibly and manage property-related expenses. That's all. You'll see that several factors critical to a traditional loan approval are of lesser consequence in a HECM approval process. One important point: Your debt-to-income ratio is not important for a HECM loan approval. The HECM program does not require lenders to calculate your DTI ratio.
The lender must tally your residual income. Your residual income is the difference between your monthly income and expenses. This calculation demonstrates your ability to meet your monthly obligations and stay out of financial trouble.
Residual income = Total monthly income - Total monthly expenses
1.) Your lender adds up your income, including wages, commissions, self-employment earnings, pensions, Social Security benefits, investment income and disbursements from savings accounts. It doesn't include the income of a non-borrowing spouse.
2.) Your lender subtracts expenses from total income. Your expenses include:
- Federal and state income taxes.
- Property charges (taxes, homeowners insurance and homeowner's association fees).
- Estimated utility and maintenance expenses (0.14 multiplied by the square footage of home).
- Installment account payments (auto loans and student loans).
- Expenses for additional properties.
- Revolving account payments.
- Alimony and child support payments.
- Non-borrowing spouse's obligations if property is located in a community property state.
3.) After it finishes calculating your residual income, the lender refers to a HUD table to determine whether your income is acceptable.
8 Factors Lenders Consider for the HECM Financial Assessment
Your lender's financial assessment also includes verification of any federal monetary obligations. You must clear or subordinate any federal liens against the property before you can proceed with a HECM loan. Additionally, if your lender finds any federal judgments or delinquent federal debt in your name, you are not eligible for a HECM until you pay the obligation in full or establish a satisfactory repayment plan.
Liens against the property relating to outstanding state or local court judgments must be satisfied, removed or subordinated to the HECM. The FHA, however, doesn't require HECM applicants to satisfy unpaid state or local court-ordered judgments unrelated to the property. Nevertheless, your particular HECM lender may require that you clear any unpaid judgments.
Credit Alert Verification Reporting System, or CAIVRS (pronounced "cavers"), is a database containing the names of individuals who have defaulted on government debt. If your name turns up on CAIVRS for a default on an FHA loan within the last three years, you can still successfully apply for a HECM loan, provided the lender obtains a HUD waiver on your behalf.
Your Credit History
To pass the financial assessment, your HECM lender must confirm your satisfactory credit history. Satisfactory credit history includes:
- No property tax arrearages in the 24 months before applying.
- No past-due payments of property taxes, HOA dues and homeowners insurance.
- Homeowners insurance policy that has been in place for at least 90 days prior to applying.
- No history of late revolving, installment and mortgage payments.
- No major derogatory credit on revolving accounts.
If you have a solid track record of payments, sufficient income and satisfactory credit, you should encounter no problems passing the assessment and obtaining approval to borrow without restriction. Your lender will also determine whether you have independently paid taxes and insurance or if your mortgage lender has always managed that obligation on your behalf. If your mortgage lender handled the tax and insurance payments and you have other risk factors, your HECM lender may require a withholding of proceeds for these items.
Derogatory Credit History Items
What if you have a history of derogatory credit? According to HUD, a significant derogatory item increases the lender's risk and the likelihood of a future default. Nevertheless, the derogatory may not necessarily derail your HECM application.
Your lender is required to:
- Determine the cause and extent of your derogatory credit.
- Calculate how much time has passed since the last derogatory event.
- Confirm that you have resolved credit problems and re-established credit or refrained from using credit.
- Analyze your mortgage payment history.
- Take into account extenuating circumstances and situations beyond your control.
Extenuating Circumstances and Compensating Factors
Many HECM applicants are cash-strapped, which is precisely the reason they seek financing. A HECM loan would enable them to pay their bills in a timely manner. Perhaps you fall in this camp. Rest assured, HUD does not overlook this fact. It also understands that not all derogatory credit is the applicant's fault. Extenuating circumstances, events out of a borrower's control, might have contributed to your less-than-stellar credit history. The good news is that lenders must consider any extenuating circumstances when conducting your financial assessment. If you have any damaging factors in your credit history, the existence of an extenuating circumstance works to your advantage because it increases your chances of a HECM loan approval.
Examples of extenuating circumstances:
- Loss of income due to the death of a breadwinner.
- Sudden unemployment or drastically reduced work hours.
- Medical emergencies.
Compensating factors also work to your advantage in your financial assessment. The lender can use compensating factors to offset negative aspects of your application.
Examples of compensating factors:
- Small withdrawal at closing (less than 60 percent of principal limit) with access to future HECM funds.
- Residual income 150 percent or higher than required.
- History of timely payment of accounts, taxes and insurance even with lower residual income.
- Borrower use of HECM funds to retire a mortgage for which the borrower has a good payment history.
- Overtime, bonus, part-time and seasonal income, provided the income is likely to continue.
Even if your current financial position isn't rock solid, the addition of the HECM proceeds may bolster your position and play a role in your HECM loan approval. In addition to extenuating circumstances and compensating factors, HUD requires that your lender consider:
- Accounts to be closed and payments to be eliminated by the HECM.
- Increase in monthly income with monthly payments from the HECM
What happens if your lender determines it can't depend on you to keep up with property-related expenses? It may still approve your HECM loan with some conditions. Depending on the distribution method you choose for your HECM proceeds, the lender may set aside a lump sum of the reverse mortgage to pay for future obligations, obtain authorization from you to hold back a portion of your monthly payouts or use your line of credit to cover these payments before it agrees to approve the reverse mortgage loan.
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