HomeQualifying
Qualifying for a Reverse Mortgage
Turned down by a bank? Different test.
Since the financial crisis of 2008, lenders have been required to document every borrower’s “ability to repay” a home loan — and reverse mortgages are no exception. The difference is in how that ability is measured.
50%
The bank’s test
Debts against gross income
$589
HUD’s minimum, one person
What must be left to live on
$1,320
Left over, after
One check, approved
LESA
The set-aside
Partial or full, and why
Two ways to measure ability to repay
The bank divides. The reverse subtracts.
How a traditional mortgage is qualified
≤ 50%
On a traditional (“forward”) mortgage, this generally means your housing payment plus all of your other monthly debts can’t exceed about 50% of your gross monthly income. For example, a borrower with a $3,000 house payment and $6,000 in monthly income has a 50% debt-to-income ratio — right at the typical limit.
The question
What share of income goes to debt?
How a reverse mortgage is qualified
What’s left
Reverse mortgages use a different standard, called the residual income method. Instead of a debt-to-income ratio, it asks a simpler question: how much money is left over each month to live on, after housing costs? HUD sets a minimum required residual income based on household size:
HUD Minimum Monthly Residual Income
One person in the household
$589
Two people in the household
$998
Draft: West-region figures to confirm before launch
Residual income
Residual income is what remains each month after housing expenses and debts — the amount left to live on.
A real-world example
One check gone. The house, kept.
Here’s a scenario I run into often: a spouse passes away, and the household loses one Social Security check.
Home value
$600,000
Size
2,000 sq. ft.
Property taxes
$6,600/year
Monthly Social Security income
$2,350
Before a reverse mortgage
Monthly debts
Mortgage payment (balance: $200,000)
$850
Property taxes & insurance
$750
Credit card payments (balance: $30,000)
$200
Car payment (balance: $22,000)
$346
Total monthly debts
$2,146
90%+
debt-to-income
About 50%: the typical limit
Against $2,350 in monthly income, that’s a debt-to-income ratio of over 90% — she wouldn’t qualify for any new credit under standard lending guidelines. Nearly every dollar coming in is already spoken for. This borrower is literally drowning in their finances. There is NOTHING left to live on in this scenario.
After a reverse mortgage
A reverse mortgage can often pay off the existing mortgage balance and consumer debts entirely, leaving the borrower responsible only for property taxes, insurance, and upkeep. Using the residual income method:
Residual income method
Social Security income
$2,350
Property taxes & insurance
−$750
Maintenance & utilities allowance
HUD allows 14¢ per square foot of home size (2,000 sq. ft. × $0.14)
−$280
Residual income — Approved
$1,320
$589 minimum
$1,320
At $1,320 a month, she clears the $589 minimum required for a one-person household — comfortably.
From having to sell her home and rent, to a position where she can age in place — with room to breathe.
And that’s the goal of the reverse mortgage product: to help seniors age in place.
The Life Expectancy Set-Aside (LESA)
Short on the test? Set some aside.
When a borrower hasn’t been consistent with property tax and insurance payments over the last two years, or their income falls just short of the residual income requirement, a Life Expectancy Set-Aside (LESA) may be required to secure loan approval.
A LESA sets aside part of the loan proceeds to make sure property taxes and homeowner’s insurance continue to be paid on time. As each tax or insurance installment comes due, the amount needed is forwarded from the set-aside to cover it.
Because a LESA reduces the loan proceeds available to the borrower, it can sometimes be a deal-breaker if the remaining numbers no longer work.
Partial LESA
Full LESA
When
Used when a borrower is just a little short on the residual income requirement — for example, a $598 requirement against $500 in residual income.
Required when the borrower hasn’t been consistent keeping taxes and insurance current.
How much
Sets aside only enough to cover the shortfall — not the borrower’s full expected lifetime — so the borrower is likely to outlive the curtailment.
Sets aside a larger sum, intended to cover taxes and insurance for the borrower’s foreseeable lifetime.
The effect
Holds back less of the loan — may keep the deal together.
Holds back more of the loan — could be a deal-breaker if the numbers no longer work.
Either way, no one knows exactly how long a borrower will live. A borrower can outlive even a Full LESA — at which point they’d need to cover taxes and insurance from their own resources going forward.
A LESA worked example
Age 75. Twelve years of taxes.
Borrower age
75
Annual property taxes
$1,092
Annual insurance
$804
Life expectancy
12 years (144 months)
To fully fund the set-aside for this borrower would require curtailing $18,658 of the credit line:
Financial Assessment Decision
Applied Age: 75 -> Life Expectancy: 144 months
✓
Property Charge Payment History Acceptable
✓
Credit History Acceptable
✕
Residual Income Acceptable
LESA Calculated Value
18,658.21
LESA Decision
Fully Funded LESA Required
LESA Amount
18,658.21
LESA Percentage
100%
First Year LESA Disbursement
1,896.96
Net LESA
16,761.25
Transcribed from a lender’s screen in Todd’s document
Draft: builder places Todd’s screenshot
The catch
Rounding taxes and insurance to $2,000 a year, that $18,658 set-aside isn’t enough to cover 12 years of payments — meaning there could come a point where the borrower needs to cover those payments from their own resources.
Read the rules yourself
The handbook, all 241 pages.
For those of you that want to read HUD’s actual guidelines surrounding the product, click on the link below to access the reverse mortgage portion of the handbook:
OFFICIAL HUD REFERENCE
HUD Handbook 4000.1
FHA Single Family Housing Policy Handbook
Section II.B — Reverse Mortgages (HECM)
Origination · Underwriting · Closing · Endorsement Requirements
241 pages · Compiled by Todd Walcott, CRMP · Contempo Lending
VIEW THE FULL HANDBOOK →
Draft: “Official HUD reference” wording, for Contempo compliance
Draft: bit.ly destination unchecked
A bank said no. Ask the other question.
An anonymous estimate first, no name needed. Or send your numbers and Todd runs the residual-income test with you.