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UNDERSTANDING ASSOCIATED FEES and OPTIONS

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UNDERSTANDING ASSOCIATED FEES and OPTIONS

Financial assessment involves evaluating two main areas

On March 2, 2015, the FHA implemented new guidelines that require reverse mortgage applicants to undergo a financial assessment. Although HECM borrowers are not required to make monthly mortgage payments, FHA wants to make sure they have the financial ability and willingness to keep up with property taxes and homeowner’s insurance (and any other applicable property charges).

It has become apparent that the actual reason for Financial Assessment (FA) is because the FHA HECM has an “entitlement loan” similar to Social Security. A lender could not refuse a request for a HECM before 2015 because the requirement is age 62, own a home and meet initial debt-to-equity requirements before. With FA, the lender may now force equity “set aside” rules and sums that make the loan impossible. This is nearly the same as a declination letter for poor credit.

 

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Financial assessment involves evaluating two main areas:

  • Residual Income. Borrowers must have a certain amount of residual income left over after covering monthly expenses.
  • Satisfactory Credit. All housing and installment debt payments must have been made on time in the last 12 months. Additionally, there are no more than two 30-day late mortgage or installment payments in the previous 24 months, and there is no derogatory credit on revolving accounts in the last 12 months.

The lender can possibly make up for it by documenting extenuating circumstances that led to the financial hardship if residual income or credit does not meet FHA guidelines. If no extenuating circumstances can be documented, the borrower may not qualify at all or the lender may require a large amount of the principal limit to be carved out into a Life Expectancy Set Aside (LESA) for the payment of property changes (property taxes, homeowner’s insurance, etc.)



Learning About the Particulars

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The HECM reverse mortgage offers fixed and adjustable interest rates. The fixed-rate program comes with the security of an interest rate that does not change for the life of the reverse mortgage, but the interest rate is usually higher at the start of the loan than a comparable adjustable-rate HECM. Adjustable-rate reverse mortgages typically have interest rates that can change on a monthly or yearly basis within certain limits.

Applicants for a HECM reverse mortgage may notice there are two different rates disclosed on their loan documents: the initial interest rate, or IIR, and the expected interest rate, or EIR.

Unlike traditional forward mortgages, there are no escrow accounts in the reverse mortgage world. Property taxes and homeowners’ insurance are paid by the homeowners on their own, which is a requirement of the HECM program, along with the payment of other property charges such as HOA dues.

If a reverse mortgage applicant fails to meet the satisfactory credit or residual income standards required under the new financial assessment guidelines implemented by FHA on March 2, 2015, the lender may require a Life Expectancy Set Aside, or LESA. A LESA carves out a portion of the reverse mortgage benefit amount for the payment of property taxes and insurance for the borrower’s expected remaining life span. FHA implemented LESA to reduce defaults based on the nonpayment of property taxes and insurance.

The American Bar Association guide [40] advises that generally,

  • The Internal Revenue Service does not consider loan advances to be income.
  • Annuity advances may be partially taxable.
  • Interest charged is not deductible until it is actually paid, that is, at the end of the loan.
  • The mortgage insurance premium is deductible on the 1040 long form.
  • The money used from a reverse mortgage is not taxable.

The money received from a reverse mortgage is considered a loan advance, meaning it’s not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide to reverse mortgage solutions explains that if borrowers receive Medicare, SSI or other public benefits, loan advances will be counted as “liquid assets” if the money is kept in a bank account past the end of the calendar month it is received. It must be noted that the borrower could then lose eligibility for such public programs if total liquid assets (cash, generally) become greater than those programs allow.

The HECM reverse mortgage is not due and payable until the last borrower (or non-borrowing spouse) dies, sells the house or fails to live in the home for a period greater than 12 months. The loan may also become due and payable if the borrower fails to pay property taxes and/or homeowner’s insurance, lets the condition of the home significantly deteriorate or transfers the title of the property to a non-borrower (excluding trusts that meet HUD’s requirements).

Borrowers or heirs of the estate have several options to settle the loan balance once the mortgage comes due:

  • Pay off or refinance the existing balance to keep the home.
  • Sell the home themselves to pay the loan balance (and keep the remaining equity).
  • Allow the lender to sell the home (and the remaining equity is distributed to the borrowers or heirs).

The initial interest rate, or IIR, is the actual note rate at which interest accrues on the outstanding loan balance on an annual basis. The IIR can never change for fixed-rate reverse mortgages. For adjustable-rate reverse mortgages, the IIR can change with program limits up to a lifetime interest cap.

The expected interest rate, or EIR, calculates how much a reverse mortgage borrower qualifies for based on the value of the home (up to the maximum lending limit of $726,525) and age of the youngest borrower. The EIR is often different from the actual note rate, or IIR, because it doesn’t determine the amount of interest that accrues on the loan balance.

The money from a reverse mortgage can be distributed in four ways, based on the borrower’s financial needs and goals.

  • Lump sum in cash at settlement,
  • Monthly payments (loan advancement) for a set number of years (term) or life (tenure),
  • Line of credit (similar to a home equity line of credit) or
  • Some combination of the above.

Note that the adjustable-rate HECM offers the above payment options, but the fixed-rate HECM only offers a lump sum.

The line of credit option accrues growth, meaning whatever is available and unused on the line of credit will automatically grow larger at a compounding rate. This means that borrowers who opt for a HECM line of credit can potentially gain access to more cash over time than what they initially qualified for at origination.

The line of credit growth rate is determined by adding 1.25% to the IIR, which means the line of credit will grow faster if the interest rate on the loan increases.

In September of 2013, HUD implemented Mortgage Letter 2013-27, which made significant changes to the amount of proceeds that can be distributed within the first year of the loan [35]. HUD sought to protect borrowers and the viability of the HECM program by limiting the amount of proceeds that can be accessed within the first year of the loan. This is because many followers were taking full-draw lump sums (often at the encouragement of lenders) at closing and burning through money quickly.

If the total mandatory obligations (which includes existing mortgage balances, closing costs, delinquent federal debts and purchase transaction costs) paid by the reverse mortgages are less than 60% of the principal limit, then the borrower can draw additional proceeds up to 60% of the principal limit in the first year. Any remaining available proceeds can be accessed after one year.

The borrower can draw an additional 10% of the principal limit -- if available -- if the total mandatory obligations exceed 60% of the principal limit.

The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds -- the so-called HECM for Purchase program, effective January of 2009. The “HECM for Purchase” applies if “the borrower is able to pay the difference between the HECM and the sales price and closing costs for the property.” The program was designed to allow the elderly to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. Texas was the last state to allow for reverse mortgages for purchase.

Reverse mortgage closing costs are frequently criticized because they can be expensive. This opinion stems from the inclusion of the FHA Upfront Mortgage insurance which protects the borrower, and “broker paid compensation” is a customary part of the loan that has nothing to do with the borrower’s checkbook or equity balance. Considering the restrictions imposed upon HECM loans, they are comparable to their “forward” contemporaries in overall costs. The following are the most typical closing costs paid at closing to obtain a reverse mortgage:

  • Counseling fee: It’s important to go through a counseling session with a HUD-approved reverse mortgage lender. The average cost of the counseling session is around $125.
  • Origination fee: This is charged by the lender to arrange the reverse mortgage. Origination fees can vary widely from lender to lender and can range from nothing to a maximum of $6,000.
  • Third-party fees: These fees are for third-party services hired to complete the reverse mortgage, such as appraisal, title insurance, escrow, government recording, tax stamps (where applicable), credit reports, etc.
  • Initial Mortgage Insurance Premium (IMIP): This is a one-time cost paid at closing to FHA to insure the reverse mortgage and protect both lenders and borrowers. The IMIP protects lenders by making them whole if the home sells at the time of loan repayment for less than what is owed on the reverse mortgage. This also protects borrowers because it means they will never owe more than their home is worth. As of January of 2019, the IMIP is now 2% of the max claim amount (the appraised value of the home up to a maximum of $726,535). The annual MIP (mortgage protection premium) is .5% of the outstanding loan balance.

The vast majority of closing costs typically can be rolled into the new loan amount (except in the case of HECM for purchase, where they’re included in the down payment), so they don’t need to be paid out-of-pocket by the borrower. The only exceptions to this rule may be the counseling fee, appraisal fees and any repairs that may need to be done to the home to make it fully compliant with the FHA guidelines before completing the reverse mortgage.

Lenders disclose estimated closing costs using several standardized documents, including the Reverse Mortgage Comparison, Loan Amortization, Total Annual Loan Cost (TALC), Closing Cost Worksheet and the Good Faith Estimate (GFE). These documents can be used to compare loan offers from different lenders.

There are two ongoing costs that may apply to a reverse mortgage: annual mortgage insurance and servicing fees. The IMP of 2% of the appraised value is charged at closing. The IMIP is the largest cost associated with an FHA HECM or reverse mortgage. The cost is typically added to the initial loan amount and does not need to be paid out of pocket. The annual mortgage insurance is charged by FHA to insure the loan and accrued annually at a rate of .5% of the loan balance. Annual mortgage insurance does not need to be paid out-of-pocket by the borrower, but it can be allowed to accrue onto the loan balance over time.

Servicing fees are less common today than in the past, but some lenders may still charge them to cover servicing the reverse mortgage over time. Servicing fees, if charged, are usually around $30 per month and can be accrue onto the loan balance (they don’t need to be paid out of pocket).

Amount of Reverse Mortgage Proceeds Available

The total pool of money that a borrower can receive from a HECM reverse mortgage is called the principal limit (PL), which is calculated based on maximum claim amount (MCA), the age of the youngest borrower, the EIR and a table to PL factors published by HUD.

Similar to loan-to-value (LTV) in the forward mortgage world, the PL is the percentage of the value of the home that can be lent under the FHA HECM guidelines. Most PLs are typically in the range of 50% to 60% of the MCA, but they can sometimes be higher or lower. The table gives examples of PLs for various ages and EIRs and a property value of $250 thousand.

reverse mortgage rate table

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