NEW YORK (MainStreet) — One of the greatest things about reverse mortgages, as everyone surely knows, is that you need no steady income to qualify. Why would you, since there are no monthly payments? This feature makes a reverse mortgage a great option for late in life, when other assets are dwindling.
Well, it's not quite so simple — not anymore. Starting March 2, borrowers will have to show they have the resources to keep up with property taxes and homeowner's insurance premiums. Applicants who are tapped out could be rejected, and others with resources deemed insufficient could find a big chunk of their loan earmarked for these expenses, reducing their money-managing options.
To be on the safe side, homeowners who had thought a reverse mortgage could someday provide a safety net should review their strategy to figure just how they'd pay taxes and premiums.
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The Federal Housing Authority imposed the new rules several months ago to curb the growing number of reverse mortgage borrowers who default by not paying property tax and homeowner's insurance premiums. Starting March 2, lenders will have to assess applicants' debt burdens, credit ratings, payment histories, income from Social Security and other sources.
If that sounds a lot like the process you'd go through for an ordinary mortgage, it is. The good news is that since the borrower makes no principal and interest payments on a reverse mortgage, the income requirements will be much lower than they would be on a conventional mortgage of the same size. But this could still be a major hurdle for people with minimal assets and modest home equity.
To be picky about it, the new rules don't really change things for a responsible applicant, because borrowers have always been required to keep up with taxes and premiums. But this is a hurdle that, at a minimum, will require more paperwork and possibly make the approval process take longer.
Many borrowers probably plan on setting aside some of the funds from a reverse mortgage to pay taxes and insurance, but now they could find the lender requiring this through an option called a Fully-Funded Life Expectancy Set-Aside. Jack M. Guttentag, emeritus finance professor at the Wharton School, illustrates how this could work:
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I calculated the required Set-Aside for a borrower of 75 with life expectancy of 144 months, taxes and insurance charges of $5000 a year, and interest rate plus mortgage insurance premium of 5%. It was $54,000, not a trivial sum.
He notes that if this borrower had only $100,000 in home equity, the set-aside would take all the proceeds from the reverse mortgage. That's because lenders will not approve a loan equal to all the equity in the home. Some of the equity must be reserved to pay the interest on the loan after the borrower dies, moves out or sells the property.
The borrower in the example might opt for the reverse mortgage despite this set-aside requirement, because to remain in the home the property tax and insurance premium would have to be paid somehow. But the set-aside would obviously limit the borrower's options for choosing which assets to use for which purposes.
All this is a reminder that a reverse mortgage is not a free lunch. Though it can be a great way to tap home equity to help with living expenses in old age, tax and insurance expenses linger on.
— By Jeff Brown for MainStreet