When your clients ask if a reverse mortgage could result in foreclosure, the answer is yes. However, when clients think of foreclosure, they think of the most common reason traditional (forward) loans end in foreclosure – failure to make the required monthly mortgage payment. Of course, that wouldn’t make sense with a reverse mortgage that carries no monthly repayment obligation. So, it’s understandable why your clients, their heirs, and the media are often confused when they see that reverse mortgage foreclosures happen from time to time. It’s important to note that a foreclosure can be the natural resolution of a reverse mortgage after the borrower passes away. If the balance due exceeds the home’s value, or there is no next of kin to handle a sale, the estate will simply allow the home to go into foreclosure. Let’s take a more in-depth look into factors that can lead to this outcome.
Why would a foreclosure occur?
Even though reverse mortgages don’t require a monthly principal and interest mortgage payment during the life of the loan, there are other borrower obligations contained in the reverse mortgage loan agreement. The borrower has agreed to occupy and maintain the home as well as pay all property-related charges. Failure to do these things will cause the loan to mature. When a loan maturity event happens, the borrower (or their heirs) will often sell the home to pay off the loan balance.
For example, when the last surviving borrower leaves the home for 12 consecutive months for mental or physical incapacity (e.g., nursing home or assisted living), that is a maturity event. The borrower or their heirs will often notify the lender of their intentions to sell the house. The lender will then allow them six months to sell the home, and HUD generally approves two 3-month extensions for up to one year.
If no action is taken to sell the home, the lender will need to foreclosure on the house and handle the sale themselves so that the loan can be repaid.
What are the most common reasons?
- No equity remains at loan maturity
When the loan matures, the loan balance sometimes exceeds any reasonable sales price of the home. In such cases, they have no economic incentive to sell the house on their own. Fortunately for the borrower and their heirs, all reverse mortgages are “non-recourse” loans and offer them the opportunity to simply walk away despite a loan deficiency. This should not impact their credit profile. Nevertheless, foreclosure is the mechanism that conveys title to HUD (or the Lender) so they can sell the home and ultimately to pay off at least a portion of the loan balance.
- A property tax default occurs
Failure to pay property taxes will almost always result in foreclosure. This is true whether the homeowner has a reverse mortgage, a traditional mortgage, or no mortgage at all. Sadly, for the lender, they are the major lien-holder on the home and are required by federal guidelines to foreclose on the property for most reverse mortgages. Therefore, in 2015, HUD established a required financial assessment of every borrower that has dramatically reduced the number of property charge defaults.
Keep in mind, a reverse mortgage naturally allows your client access to funds, which should theoretically reduce the likelihood that they will default on their obligations. But with the increased financial pressures of retirement, we cannot always guarantee a perfect outcome. However, there are new protections in place to help protect your clients.
New borrower protections against reverse mortgage foreclosures
While nothing can be done to keep people from the grave, two measures were implemented by HUD over the last six years that have helped reduce the numbers of foreclosures caused by tax defaults – Initial Disbursement Limits and Financial Assessment.
Initial disbursement limits were implemented for all FHA-insured reverse mortgages in 2013. For the first year of the loan, many borrowers are limited on draws from their calculated proceeds. Unless they have large mortgage payoffs that necessitate higher draws, the borrower may be initially limited to 60% of their funds. As a result, most borrowers keep a portion of their proceeds in a growing line-of-credit available for future emergencies.
Financial Assessment was implemented in 2015, requiring the lender to examine the credit history, property charge history, and residual income for one primary reason – to determine whether the reverse mortgage is a sustainable solution for the borrower. To ensure sustainability, some borrowers are now required to set-aside a portion of the proceeds for the payment of property charges. This has reduced the number of reverse mortgages nationwide but has also reduced the number of foreclosures.
Yes. Foreclosures can happen, and they will continue to occur. However, the reasons for the foreclosure are quite different than those of a traditional mortgage. The mandatory reverse mortgage counseling session covers these concepts.
As with all significant financial decisions, a reverse mortgage should be part of an overall strategic plan for your clients. Contact a FAR representative if you have any questions about how to use a reverse mortgage to enhance your clients’ retirement plan.
Oregon Only:·When the loan is due and payable, some or all of the equity in the property that is the subject of the reverse mortgage no longer belongs to borrowers, who may need to sell the home or otherwise repay the loan with interest from other proceeds. FAR may charge an origination fee, mortgage insurance premium, closing costs and servicing fees (added to the balance of the loan).·The balance of the loan grows over time and FAR charges interest on the balance.· Borrowers are responsible for paying property taxes, homeowner’s insurance, maintenance, and related taxes (which may be substantial). We do not establish an escrow account for disbursements of these payments. A set-aside account can be set up to pay taxes and insurance and may be required in some cases. Borrowers must occupy home as their primary residence and pay for ongoing maintenance; otherwise the loan becomes due and payable. The loan also becomes due and payable (and the property may be subject to a tax lien, other encumbrance, or foreclosure) when the last borrower, or eligible non-borrowing surviving spouse, dies, sells the home, permanently moves out, defaults on taxes, insurance payments, or maintenance, or does not otherwise comply with the loan terms. Interest is not tax-deductible until the loan is partially or fully repaid.
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