Dissipation of documented assets can be used as a compensating factor to help a HECM reverse mortgage applicant overcome a residual income shortfall.
Residual income is an important part of the financial ability component of the HECM reverse mortgage financial assessment guidelines implemented in 2014. The residual income calculation helps lenders determine if an applicant has adequate income to keep up with property charges as required by the HECM program.
If an applicant doesn’t meet the residual income standard, the lender may be required to set up a life expectancy set-aside (LESA) unless the applicant can document compensating factors that make up for the income shortfall.
One of the allowable compensating factors under the FHA guidelines is asset dissipation. Any proven cash asset can potentially be dissipated, including funds in 401(k) accounts, IRAs, Roth IRAs, checking accounts, savings accounts, money markets, etc.
How dissipation works
How much can be dissipated first depends on whether the asset is taxable or not. If the asset can be converted to cash with no tax penalty (such as checking accounts, money markets, Roth IRAs, etc.), then 100% of the asset can be dissipated. If the asset can only be converted to cash with a tax penalty (401(k) accounts, traditional IRAs, etc.), then only 85% of the asset can be used for dissipation.
The amount of imputed hypothetical income is calculated by dividing the qualifying value of the asset by the estimated remaining life span of the borrower (based on Loan Period 2 of the Assumed Loan Periods for Computations of Total Annual Loan Cost Rates).
As an example, let’s assume a borrower has $100,000 in a Roth IRA (which isn’t taxable), 12 years estimated lifespan remaining, and a residual income shortfall of $500. With a remaining estimated lifespan of 12 years (144 months), the imputed monthly income from asset dissipation would be $694.44/month ($100,000 divided by 144 months).
As you can see, the imputed income from the Roth IRA makes up for the residual income shortfall in this example. These assets could make it possible for this borrower to avoid a LESA or be declined altogether.