Financial Assessment has finally arrived. The long-anticipated move by FHA will tighten underwriting standards for HECM loans, requiring lenders to evaluate a borrower’s credit history, income and debt to determine if they are capable of meeting the obligations of the loan.
The value of Financial Assessment has generated endless chatter in the past year among reverse professionals, as many speculated how such a move would impact potential borrowers. While some were incensed by the idea, certain that it would exclude those who needed the loan most, others were confident that it would encourage lenders to connect with a more financially savvy client and help make the program more sustainable for the long term.
Opinions aside, Financial Assessment is here to stay. In effect, this last program change further solidifies the concept of a “new reverse mortgage,” the one that industry leaders have been touting as a way to engage the public in a new conversation about the loan. With these latest guidelines in place, reverse mortgages will take on a new shape. It’s a chance for lenders to revitalize the dialogue about HECMs and potentially expand the market to reach thousands of seniors who stand to benefit from this financial tool.
Determining Ability and Willingness
FHA announced its intent to make substantial changes to the HECM program last fall, following the passage of the Reverse Mortgage Stabilization Act of 2013. The agency issued a mortgagee letter that detailed, among other changes, new principal limit factors and utilization restrictions. The letter included some information on a pending financial assessment of borrowers, but it was not until 14 months later, after sorting through feedback from the industry, that the agency released the final details of this new mandate.
FHA’s final Financial Assessment includes nearly 90 pages of specific criteria that a lender must consider when assessing a borrower’s “ability and willingness” to meet the loan’s financial obligations, specifically, to continue to pay their property taxes and insurance.
As part of the new assessment, FHA has stated that lenders must “take into consideration that some mortgagors seek a HECM due to financial difficulties, which may be reflected in the mortgagor’s credit report and/or property charge payment history. The mortgagee must also consider to what extent the proceeds of the HECM could provide a solution to any such financial difficulties.” In order to accomplish this, lenders will need to institute a new kind of underwriting, one that more closely resembles requirements on the forward side.
Under Financial Assessment, lenders must take the following into account:
-Credit history using credit reports from all three national credit bureaus -Income from retirement accounts, Social Security, employment or investments -Assets -Payment history on property taxes, insurance and homeowner’s fees -Debt, including medical bills and credit cards
If a borrower’s analysis appears weak, lenders can consider any extenuating circumstances that might have contributed to their troubles, such as an illness. But those who still fall short will be denied or required to set aside a portion of their loan proceeds to ensure the payment of property taxes and insurance.
Following the new rule’s release, HUD hosted two conference calls for industry participants to explain specifics and address questions. HUD Director Karin Hill expressed the agency’s willingness to help lenders adapt to the changes.
“We certainly are aware that [these new rules] have a significant impact on your operations and systems—affecting originators, affecting HUD, counselors, quality assurance,” Hill said. “We want to make sure you’re prepared internally and externally to support the new policies.”
While the agency has done its best to answer ambiguities, some questions remain. In particular, originators are concerned about a new stipulation calling for Seasoning Requirements for non-HECM liens, something that has not been required for HECM loans in the past. On a conference call with the industry, Hill said HUD will evaluate the issue and release a response via mortgagee letter in the coming months. (For more details on Seasoning Requirements and how it could impact borrowers, see Richard Wills’ article on reversereview.com.)
Encouraging Long-Term Sustainability
The move toward Financial Assessment is one that many industry analysts called essential to the program’s viability. A 2012 report revealed that nearly 10 percent of all HECMs that year had ended in foreclosure because borrowers were failing to make tax and insurance payments. The defaults caused a significant drain on FHA’s Mutual Mortgage Insurance Fund, requiring an unprecedented $1.7 billion bailout from the Treasury.
The need for some sort of financial assessment was discussed even before the program’s drain on the Treasury came to light. In 2011 MetLife led the charge, asking its originators to examine borrowers’ credit histories. The move caused backlash as originators, upset that the guidelines prevented a number of borrowers from qualifying, moved their business elsewhere. MetLife finally suspended the program before leaving the space all together. Genworth, now Liberty Home Equity Solutions, also attempted to institute its own assessment, but its industry partners failed to catch on.
Now, by instituting a mandatory, industrywide Financial Assessment, FHA is taking steps to prevent riskier borrowers from entering into the loan. It’s an idea that is supported by recent research from Ohio State. Led by economic professors Stephanie Moulton, Donald Haurin and Wei Shi, the study analyzed the credit history of hundreds of reverse mortgage borrowers to determine that those with lower credit scores are more likely to end up in default. According to Moulton, a financial assessment is a smart move on FHA’s part.
“The findings from our research suggest that the recent changes incorporated in the Financial Assessment—specifically, minimal credit-based underwriting criteria combined with property tax and insurance set-asides for those not meeting the criteria—can significantly reduce the occurrence of technical defaults without substantially restricting access to the product.” Moulton says. “These changes are important to ensure the long-term viability of the program.”
Those opposed to the institution of Financial Assessment have expressed concern that stiffer requirements will turn away a large portion of low-income seniors whose situations could be significantly improved by the loan. In 2012, AARP and the National Council on Aging (NCOA) stated their support for some sort of financial assessment, but both expressed concern that an overly restrictive policy would shut out too many borrowers.
Ramsey Alwin, vice president of economic security at NCOA, says the council is confident that the new guidelines will ensure the product’s use as a long-term financial planning tool. Alwin says NCOA will do what it can to help lower-income seniors take advantage of the loan.
“As we navigate the details of Financial Assessment and what that will look like from the origination side, we will be watching closely and working with FHA, HUD, NRMLA to try to ensure that our most vulnerable seniors who may be cash-poor and house-rich still have the opportunity to utilize the product in a way that can ensure their financial stability,” Alwin says. “We’ll be looking closely at what it really looks like once credit reports are required and looking at some of the exceptions that are allowable there.”
Alwin also says BenefitsCheckUp, NCOA’s free online screening tool, can play a critical role by giving seniors access to public benefits that can help push the needle in their favor. “We’ll also be looking at the role public benefits can play in helping free up supplemental income to provide enough residual income that the product continues to be a viable option for someone, especially property tax relief programs. We work really hard to make sure our borrowers understand at the counseling phase the full range of community resources available to them, including property tax relief programs that are identified on the benefitcheckup.org screening that may impact their budget.”
The bottom line for the industry is that some sort of action was needed in order to make the program viable for the long term. Reverse Funding’s Joe Demarkey says Financial Assessment will benefit the industry in the long run. “It helps ensure that a potential HECM borrower can afford their loan and can successfully age in place,” he says. “We don’t want to be in a position where somebody is placed into a loan that they can’t afford, because it usually ends in a very, very bad situation. This is good for everybody.”
Bracing for Impact
In the past, it was relatively easy for a senior to get a reverse mortgage. For the most part, interested parties simply needed to be over the qualifying age of 62, have sufficient equity in their homes and be willing to attend a counseling session. Now, with more stipulations in place, reverse professionals are speculating as to how the new guidelines will impact the market.
According to John Lunde of Reverse Market Insight, there is not a lot of data available on how many potential borrowers will no longer qualify for the loan, and it’s therefore hard to quantify the impact FA will have. Lunde says assessing the effectiveness of Financial Assessment is a twofold challenge.
“First, how many borrowers under FA who wouldn’t have defaulted be denied the loan, a product which might have made a meaningful difference in their quality of lives?” he says. “Second, some of our past default data suggests that a substantial portion of defaulted borrowers from prior years did so as a result of circumstances not observable at origination, like the death of a spouse/co-borrower or significant increases in insurance and/or property taxes. That portion of defaults will be much harder to prevent through Financial Assessment, and we should never expect default rates to go to zero for this product.”
“It would seem that the rules form a more defensible position that borrowers won’t be put into the loan if they might be reasonably expected to fail based on their circumstances at origination, and I think that’s a good thing,” Lunde says, adding that the full impact of Financial Assessment will take some time to determine. “Bottom line is the industry and HUD had to move in the direction of Financial Assessment, but we won’t know for years whether this move is too far or not far enough.”
Demarkey also says it’s hard to speculate how the market will be impacted. “No one has ever collected validated origination data and been able to correlate it against performance data, so we just don’t know,” Demarkey says. “We think that the segment of the market that will be impacted most by Financial Assessment will be those borrowers with high mandatory obligations. Most of the high mandatory obligation borrowers today take out fixed-rate HECMs, so that’s the segment of the market that might be most impacted by it.”
From a consumer standpoint, some say that little will change. Most consumers have undergone a prequalification process to obtain a forward mortgage and won’t be put off by the evaluation. “Most consumers in the country today who are obtaining mortgage financing of any kind, whether it’s a traditional mortgage or a HELOC, are used to their lender asking them for information about their income, their expenses, pulling a credit report, so on and so forth,” Demarkey says. “So from a consumer perspective, I don’t see a dramatic change in what happens at the point of sale.”
Preparing for Implementation
With an implementation date of March 2, 2015, lenders have less than three months to get a handle on the new ruling. First and foremost, they will have to train their sales teams to read credit reports and develop new processes that take into account the prequalification requirements.
According to Ralph Rosynek, The Reverse Review’s longtime underwriting expert and a seasoned industry veteran, this may take some time. “Loan originators are going to have to put their head in a processor mode, and the processors are actually going to end up being the underwriters on these things and working together with them,” Rosynek says. “It’s technical.”
Some of the assessment guidelines are also rather subjective, another factor that might take originators some time to navigate. “There are hard and fast guidelines and benchmarks, but there are also situations where you’re looking at the performance and you have to determine the willingness and ability based on their present debt structure,” Rosynek says. “There’s a slotting that’s necessary. You’ll have to decide what category they belong in and the rationalization for that. You may wonder, ‘Did I make a good choice and final decision?’”
Demarkey says a certain amount of leeway is good. “There is some subjectivity in the final guidelines and there should be, because you can’t predict every fact set that you’re going to see at some point in the future. It’s very similar to underwriting for forward mortgage loans. Everything doesn’t fit neatly into a black box,” he says. “There should be some underwriter discretion.”
Many agree that professionals with forward mortgage experience will have a leg up. “The forward underwriter has a stronger background in conditions or stipulation management and compensating factors, and coupling that with actual calculated data,” Rosynek says.
Demarkey agrees. “Clearly the biggest challenge for the industry is going to be training. I think that anybody—whether you’re a salesperson, an ops person or an underwriter—anybody with forward mortgage loan experience on their resume is probably going to find this easier because they’ve experienced this before. They’re calling it Financial Assessment, but it’s a form of underwriting. Most people on the forward side have dealt with underwriting one’s willingness and capacity to meet their loan obligations in the past,” he says. “Anybody with that sort of experience behind them will probably find this easier to adapt to.”
Incorporating the added steps for prequalification will require more than just training staff. “Lenders will have to implement new software or make enhancements to their software,” Rosynek says. “They’ve also got to retool their processes internally from a workflow standpoint, and that’s going to take some time.”
Many will also have to reassess their marketing materials. “We have to take a look at a lot of the information on our websites and all the printed collateral that we’ve done and our method of advertising in general, because it’s no longer, ‘Are you 62, do you have equity in your home and are you ready to become mortgage payment free?’” Rosynek says. “How can you use the same collateral and not speak to the fact that the qualification process is a little more cumbersome than it was before? You’re talking about a rebranding of the product from a marketing and advertising perspective. Sound bites are going to be enhanced and augmented; they’re not going to be shortened.”
With just a couple of months to prepare for FA’s implementation, lenders will have their plates full as they work to get ready. “The mad rush is going to start in February when everyone realizes the countdown is less than 30 days away,” Rosynek predicts, adding that industrywide cooperation is essential to a smooth transition. “This is really going to have to be a team effort across the industry, because it doesn’t make sense if one area of the transaction excels but others are hindered because they need more time to prepare or to become familiar. It could affect the overall image of the product again.”
Demarkey says the lead-time should be enough for industry players to get a handle on things. “I’m very confident that people are going to be able to get themselves adapted to the new way that we have to underwrite loans in time before March 2.”
In order to be ready for that March deadline, Rosynek says lenders will need to start lining things up now. “The best message we can send to the industry is: Don’t wait, don’t wait. Waiting is going to create concern for your bottom-line profits, and it could also create some issues with borrowers and nobody wants that. Start preparing now.”
A Quick Recap of the New Guidelines
TRR’s expert underwriter, Ralph Rosynek, breaks down the key elements of Financial Assessment. Here’s what you should look out for when reviewing the mortgagee letters yourself.
On November 10, 2014, FHA published “HECM Financial Assessment and Property Charge Changes” in Mortgagee Letter 2014-22. The letter provided additional guidance for mortgagees on various aspects of Financial Assessment. The complete guide is highly detailed. Be aware that the contents of the will significantly impact current HECM pre-qualification, origination and backroom processes. My recommendation to all: You must take the time to read and understand the contents of the guide before originating on March 1, 2015. The information below should not be relied upon solely and is presented as a starting point for key areas that might require extra focus in your complete review of the new rules.
A revision indicates a credit report may be pulled prior to housing counseling, but the mortgagor cannot be charged for the report prior to closing. The report does not replace the requirement for Financial Assessment. (ML 2014-21). There is no requirement for a non-borrowing spouse credit report, except where necessary to calculate residual income to be used as a compensating factor or to reduce family size, whether property is in a community property state or not (Guide Section 2.2). HUD has clarified that where a financial obligation, such as a mortgage, is being paid off, that monthly payment need not be included in the mortgagor’s expenses. (Guide section 3.77)
Satisfactory Installment and Revolving Credit
HUD has provided revised standards under which mortgagees may assess a mortgagor’s credit history in terms of the type of accounts and the type of derogatory information. Where these standards are not met, the loan is not automatically rejected; it is subject to further analysis to determine the reasons for the derogatory information. (Guide Sections 2.15, 2.16)
HUD has revised the guide to permit 100 percent of the assets to be counted, except where the withdrawals from the asset are subject to federal taxes. Where federal taxes apply, mortgagees may use the lesser of 15 percent or the mortgagor’s actual tax rate as the discount factor. (Guide Sections 3.69, 3.70). Jointly held assets may be counted, provided mortgagor can document unrestricted use. (Guide Section 3.69)
Life Expectancy Property Charges
Guide Section 5.1 should be reviewed for the definition and formula.
Credit History for HECM For Purchase
HUD has revised the guide to make clear that the credit history of non-borrowing spouses, whether the property is located in a community property state or not, need not be assessed by mortgagees. Additionally, mortgagees are not required to develop a non-traditional credit history for a non-borrowing spouse, whether the property is located in a community property state or not. (Guide Section 2.8)
Non-Borrowing Spouse and Other Non-Borrowing Household Members
Review carefully the definitions of both “non-borrowing spouse” and “household member” requirements in Guide Sections 3.5 and 3.6. Note that where a non-borrowing spouse does have a source of income sufficient to meet their financial needs, and is willing to document that income for the purposes of calculating residual income, that income may be used to reduce family size on the Table of Residual Income, or cited as a compensating factor. Treatment of household member income is also provided. Guidance on counting non-cash benefits as income when calculating residual income, or as a reduction in expenses is referenced. (Guide Sections 3.68, 3.76). HUD has revised the Guide to provide alternative documentation standards for mortgagors not required to file tax returns. (Guide Section 3.100)
Extenuating Circumstances and Compensating Factors
HUD has more clearly described the factors mortgagees must take into account when applying extenuating circumstances to the assessment. (Guide Section 4.1). HUD has revised the guide to provide a specific list of compensating factors and documentation requirements. (Guide Section 4.2)
Property Tax Exemptions and Deferrals
HUD has revised the guide to permit mortgagees to exclude property taxes where such programs are in place. Where a life expectancy set-aside must be funded, the calculation of the amount of the set-aside would not have to include the exempted charges. (Guide Section 2.26)
Requiring a Property Charge Set-Aside and Determining Partial or Fully Funded Requirement
The guide matrix provides additional guidance on when a set-aside must be fully funded, partially funded, or not required. The matrix is not intended to cover every possible set of financial types of risk, but rather to provide guidance on how mortgagees may balance different types of risk, and the strengths and weaknesses of a given financial situation. Further, in all situations, extenuating circumstances and compensating factors must be taken into account. (Guide Section 5.9)
Alternative to Fully Funded Life Expectancy Set-Aside
Review the guide information for a partially funded life expectancy set-aside, which provides semi-annual payments to mortgagor. The mortgagor pays property charges. (ML 2014-21, Guide Sections 5.5, 5.6, 5.7)