FINANCIAL ASSESSMENT. 1-Page Training Documents

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FINANCIAL ASSESSMENT

1-Page Training Documents

What is Financial Assessment?

If you have not already heard, the federally insured reverse mortgage program is going through another major change effective March 2, 2015 called Financial Assessment. For the first time, reverse mortgage lenders will be required to assess each borrower’s credit history and monthly residual income. This is a dramatic change for an industry where the focus has been primarily on the value of the home.

Why is it needed?

The first question many will ask is, “why do these things matter when originating a loan that doesn’t require monthly repayment obligations?” After all, the value of the home and the age of the borrower are the primary factors in qualifying. So, why are residual income and credit now included in the underwriting of these loans?

The answer is that these loans should not be viewed as an emergency, short-term access-to-cash, program. Home equity conversion should accomplish more than that. It should always leave the borrower with the ability to pay their property charges and monthly bills. Therefore, we need to document that ability with this assessment. The reverse mortgage MUST be a sustainable solution for the homeowner. Even though monthly mortgage payments are not required, the following are critical borrower obligations that must be required:

- Upkeep of the home in good condition

- Payment of property taxes

- Payment of homeowners insurance

- Payment of other property charges (flood insurance, HOA dues, condo dues, etc.)

These are FHA requirements, and we need to document every borrower’s ability to meet these obligations. It is important to note, however, that Financial Assessment is NOT a “yes or no” qualification of the borrower. The results of Financial Assessment are simply used to determine whether a life expectancy set-aside is needed or not.

What is a Life Expectancy Set-Aside (LESA)?

When the underwriter determines that one or more of the financial assessment tests have failed, a Life Expectancy Set-Aside (or LESA) will be required. These are funds that are removed from the borrower’s principal limit and set-aside for the purpose of paying property charges over a calculated time period. The two types of LESAs that may be required are described here:

FULLY-FUNDED LESA - The lender uses funds set-aside from the borrower’s principal limit to pay three

critical property charges; property taxes, homeowners insurance, and flood insurance (if needed). The lender pays these charges directly when the bills are due, in the same way a traditional escrow account functions.

PARTIALLY-FUNDED LESA - The lender uses funds set-aside from the borrower’s principal limit to

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Financial Assessment – Talking Points

What is FINANCIAL ASSESSMENT?

All reverse mortgage lenders are now required to evaluate your CREDIT HISTORY and monthly RESIDUAL INCOME. This is done to ensure that you are likely to be able to pay future property charges as well as your monthly bills.

What is the CREDIT (or Willingness) test?

While your credit scores are not important, your credit history and property charge history indicate a pattern of bill-paying. Derogatory credit does not automatically disqualify you, but it may indicate the need to set aside funds to pay some critical property charges in the future.

What is the RESIDUAL INCOME (or Capacity) test?

Your reverse mortgage should be a sustainable solution for you. If we cannot document sufficient residual income (after property charges and monthly bills) this could indicate the need to set aside funds to supplement your income.

What are EXTENUATING CIRCUMSTANCES?

Extenuating Circumstances are explanations for credit imperfections. This will require a formal letter of explanation from you, and an underwriter will determine the root cause of derogatory credit.

What are COMPENSATING FACTORS?

Compensating Factors are items that an underwriter will evaluate that may compensate for your low residual income. An example may be large assets that you could sell in the future if you need.

What happens if we can’t document ACCEPTABLE credit or residual income?

Financial Assessment is NOT a “yes or no” qualification. The results are simply used to determine whether a Life Expectancy Set-Aside (LESA) is needed for you or not, and the type of set-aside will be determined by your loan product and your test results.

What is a LIFE EXPECTANCY SET-ASIDE (LESA)?

These are funds* that are removed from your principal limit and set aside for the purpose of paying your property charges over a calculated time period. There are “Fully-Funded” and “Partially-Funded” LESAs.

*NOTE: You are not charged interest on set-aside funds. Set-asides simply represent a portion of your equity to which you will not have access. Any unused set-aside funds are still your equity.

What is a FULLY-FUNDED LESA?

Here the lender sets aside funds from your principal limit to pay three critical property charges; property taxes, homeowners insurance, and flood insurance (if needed). The lender pays these charges directly when the bills are due, in the same way a traditional escrow account functions.

What is a PARTIALLY-FUNDED LESA?

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Financial Assessment - Documentation

With Financial Assessment comes the need to document information. Credit reports and property charge documents are used to evaluate the willingness test. Income documents and property charge documents are used to calculate capacity. Assets may be used to calculate imputed income or as a compensating factor. The following is a list of common items that may need to be documented:

CREDIT REPORTS

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Tri-merged credit report for all borrowers APPLICATION DOCUMENTS

□ 4506-T – Allows us to order tax transcript or other tax information

□ Verification of Employment

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Verification of Deposit INCOME DOCUMENTS

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Social Security - Social Security Benefit Statement, OR a recent bank statement

□ Supplemental Security - Social Security Benefit Statement, OR a recent bank statement

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Pension - copy of the pension letter, OR a recent bank statement

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IRA/401k - most recent statement AND most recent bank statement showing receipt

□ Employment Income - document 2 years of W-2s and obtain the most recent pay stubs*

*Should cover a minimum of 30 consecutive days that show year-to-date earnings

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Self-Employment Income - the tax return with all schedules and sometimes ytd profit/loss

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Other Income – may include rental, disability, annuities, VA benefits, interest, dividend, etc. ASSET DOCUMENTS

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Checking or Savings Accounts - asset statement (calculated at 100%)

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Certificates of Deposit - asset statement (calculated at 100%)

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Roth IRAs - asset statement (calculated at 100%)

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Assets subject to Federal taxes - asset statement (generally calculated at 85%)

PROPERTY CHARGE DOCUMENTS

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Property Taxes - Printout from taxing authority

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Homeowners Insurance - Current declaration sheet

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Flood Insurance - Current declaration sheet

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Financial Assessment – Credit Guidelines

FHA WILL permit us to order a credit report prior to the completion of their counseling. However, we can ONLY collect the cost of that credit report at the time the loan closes. If the HECM loan does not close, the borrower may NOT be charged for it.

Each borrower and co-borrower are pulled, but credit scores are generally NOT NEEDED and are not considered in financial assessment. We are only looking at specific items in their credit and property charge history. Specifically, we are looking at the borrower’s payment histories in the following order:

(1) Mortgage debt and housing-related expenses; (2) Installment debts; and

(3) Revolving accounts.

They put it in this order because the severity of derogatory credit is weighted in this order. The Financial Assessment guide defines the following:

Serious Derogatory Credit - foreclosures, defaults, late mortgage payments, and late property charges. Satisfactory Credit History

 Made all housing and installment debt payments on time for the previous 12 months;

 No more than two 30-day late mortgage or installment payments in the previous 24 months; &  No “major derogatory credit” on revolving accounts in the previous 12 months.

*Note: Major derogatory credit on revolving accounts shall include any payments made more than 90 Days after the due date, or three or more payments more than 60 Days after due.

Satisfactory Property Charge History

 All property charges are current;

 No property tax arrearages in the prior 24 months;

 Homeowners and Flood are current and were in place for a minimum of the prior 12 months*; &  All HOA, condominium, PUD fees are current and no arrearages in the prior 24 months.

*Note: If the borrower did not have homeowner’s or flood insurance, borrowers must obtain and prepay for 12 months at loan closing and write letter of explanation.

So what happens if Credit is NOT SATISFACTORY?

The underwriter will need to determine whether late payments were based on a disregard for financial obligations, an inability to manage debt, or extenuating circumstances. Where no extenuating circumstances can be documented, we will require a fully funded Life Expectancy Set-Aside.

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Financial Assessment – Asset Dissipation

“…mortgagees may estimate imputed income from dissipation of liquid assets, defined as assets that can be converted to cash within one-year without payment of an IRS penalty” – FA Guide Pg. 55

Assets can be counted as Income, and this may be the easiest income to document. Keep in mind, the homeowner doesn’t have to access the funds. FHA just wants to know that they COULD be accessed if needed. The first thing we need to do is verify them.

VERIFYING

Checking and Savings - Obtain 2 months statements, or a VOD and most recent statement Retirement Accounts - Obtain most recent monthly or quarterly statement

Stock/Bonds - Obtain most recent monthly or quarterly statement

DISSIPATING

DISSIPATE means to spread them out over the youngest borrower’s life expectancy, and most assets can be counted at full value, that’s 100%. These are liquid assets like Savings and Checking Accounts, CODs, Roth IRAs, and more.

Some assets are subject to Federal taxes, and are counted at 85%. You could say that because they are subject to Federal taxes, we discount these by 15% (or less if the borrower’s actual tax rate is less). We are spreading the assets over a number of MONTHS since we want to show what their monthly income from that asset could be. The guidelines state that we are to use a yearly table and convert those years to months. The following table does that for us:

For Example:

An 81 year old (96 month life expectancy) owns a COD with a current value of $100,000. Assuming the borrower is not short to close, we can dissipate all 100% of that amount over 96 months, giving us estimated imputed income of $1,042 dollars each month.

IMPORTANT REMINDERS

- Assets may not be counted twice (as interest/dividend income and imputed/dissipated income) - Assets held with non-borrowers must include a written statement that the borrower has full

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Financial Assessment – Life Expectancy Set-Asides

“Where the mortgagee determines that the mortgagor has not demonstrated the willingness and/or the capacity to meet his or her property charge obligations, a Life Expectancy Set-Aside is required.” – FA Guide Pg. 75

LIFE EXPECTANCY SET-ASIDES (LESAs) are funds that are removed from a borrower’s principal limit and

set aside for the purpose of paying their property charges over a calculated time period. There are “Fully-Funded” and “Partially-“Fully-Funded” LESAs. The borrower is not charged interest on the set-aside funds. They simply represent a portion of their equity to which they will not have access. Any unused set-aside funds are still their equity.

FULLY-FUNDED LESA - Here the lender sets aside funds from the principal limit to pay three critical

property charges; property taxes, homeowners insurance, and flood insurance (if needed). The lender pays these charges directly when the bills are due, in the same way a traditional escrow account functions.

PARTIALLY-FUNDED LESA - Here the lender sets aside funds from the principal limit to supplement a

borrower’s income, which essentially funds a small monthly gap in the residual income. The lender will release necessary funds to semi-annually and the borrower will then pay their own property charges. How do we know which LESA to use? The need for set-asides is clarified when you look at the answers to these 2 critical questions:

1. Does the borrower pass the WILLINGNESS (CREDIT) test?

NO

Barring any extenuating circumstances, the borrower will need a Fully-Funded Life Expectancy Set-Aside (LESA)

YES

Move on to Question #2

2.

Does the borrower pass the CAPACITY (RESIDUAL INCOME) test?

NO

Barring any extenuating circumstances, the borrower will need a Partially-Funded Life Expectancy Set-Aside (LESA)

YES

No LESA is needed.

EXCEPTIONS:

There are 2 cases, where the partially-funded LESA will revert to a fully-funded set-aside.

The 75% Exception

Where the projected Partially Funded Life Expectancy Set-Aside is greater than 75% of the Projected Life Expectancy Property Charge Cost, the mortgagor is not eligible for a Partially Funded Life Expectancy Set-Aside. In other words, if your gap in residual income is that large, we would rather make sure your property charges are paid by the lender.

Fixed Rate Loan Exception

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Financial Assessment – Residual Income Required

To determine if monthly residual income is sufficient to demonstrate the financial capacity of the mortgagors to meet their financial obligations, select the applicable family size, and region from the table below.

FINANCIAL ASSESSMENT. 1-Page Training Documents