A reverse mortgage LESA, which stands for life expectancy set aside, was introduced as part of the new financial assessment guidelines rolled out by the Federal Housing Administration (FHA) in 2014. The idea behind the LESA is to help reverse mortgage borrowers with bruised credit or limited income to stay current with their required property charges (which is an important requirement of the HECM reverse mortgage program).
A LESA is set up by carving out a chunk of the principal limit (the total pool of cash available) into a set-aside that is preserved solely for the payment of property charges. The exact amount of the carve out varies widely from borrower to borrower because it is based on age and the cost of the property charges.
If the property charges are low, the total reverse mortgage LESA carve out tends to be low. If the property charges are high (such as in areas with high property taxes), the LESA can eat up a substantial portion of the loan proceeds.
It’s possible a LESA can make a reverse mortgage completely unworkable. If the home has a high mortgage balance, there may not be enough available money after paying off the existing mortgage to create the LESA. In such cases the reverse mortgage is short-to-close, which means means the borrower has to bring cash to the closing table to make the numbers work.
When a reverse mortgage LESA is required
To avoid a LESA (and to qualify at all, for that matter), applicants must demonstrate both of the following:
- A financial willingness to keep up with financial obligations (based on a credit analysis).
- A financial ability to keep up with financial obligations (based on income analysis).
If an applicant fails one of these tests, they are considered to be at greater risk of failing to keep up with the required property charges. To reduce the risk of default, FHA requires the lender to set up a LESA to ensure that the required property charges are paid for the borrower’s remaining estimated lifespan.
Financial willingness
If an applicant has excellent credit, they’ve already demonstrated a financial willingness to maintain their financial obligations. A LESA likely will not be required due to credit.
If an applicant has a few dings on credit, it’s still possible to avoid a LESA as long as the dings aren’t too serious. A 30-day late payment on a credit card here or there typically isn’t an issue. However, if there are 30-day lates or worse for mortgages or installment loans, collections, charge offs, foreclosures, bankruptcies, etc., a LESA may be required unless the applicant can document an extenuating circumstance that led to the bad credit.
If the credit issues are serious enough, the applicant may not qualify with or without a LESA.
Financial ability
Lenders determine an applicant’s financial ability by calculating residual income, which is essentially the income left over after monthly obligations are paid.
Residual income is calculated by adding up all of monthly qualifying income and deducting debt payments (excluding mortgage payments to be eliminated by the reverse mortgage), monthly property charges (property taxes, homeowner’s insurance, HOA dues, etc.), and estimated utility costs based on the square footage of the home.
The leftover residual income must meet a certain threshold based on region and the number of people living in the home. If the residual income comes up short, it’s possible to make up for it and still qualify using certain compensating factors.
If compensating factors are applied and the residual income is still short of the requirement, the lender may still approve the loan with a LESA. If the residual income is still short after applying the LESA, the loan likely will not be approved.
How a reverse mortgage LESA is calculated
The LESA set-aside amount is calculated to cover required property charges for the remainder of the youngest borrower’s (or non-borrowing spouse’s) life expectancy. For the hardcore numbers geeks out there, this is the formula used to calculate the LESA:
LESA Amt = (1.2 x MPC) × {(1 +) m+1 ‒ (1 +c)} ÷ {c × (1 +c ) m }The variables are defined as follows:
- MPC = Monthly property charges
- c = (Annual expected interest rate (EIR) + 1.25%) / 12
- m = Life expectancy of youngest borrower in months (based on Loan Period 2 in the Assumed Loan Periods for Computations of Total Annual Loan Cost Rates)
Basically, the LESA incorporates enough money to cover property taxes, homeowner’s insurance, and flood insurance (if applicable) for the youngest borrower’s (or non-borrowing spouse’s) estimated remaining lifespan. The formula also takes into account that such charges will likely increase over time due to inflation.
If there’s not enough money available in the reverse mortgage to cover the entire LESA, the loan will be short to close. In other words, the borrower would need to bring cash to the closing table to make up for the shortage or the loan doesn’t work.
Expert Tip
An important note: though the LESA is calculated to pay property charges for the rest of the borrower’s estimated life span, it’s not guaranteed to do so. It’s possible for a LESA to run out of money at some point, which means the borrower will have to resume paying the property charges.
A LESA offers peace of mind
Some people see the reverse mortgage LESA as a bad thing, but it’s a very beneficial feature of the HECM for many seniors. Think about it: if you’re seeking a reverse mortgage to reduce your bills, wouldn’t it also be nice to get rid of your property tax and insurance payments, too? There is a lot of peace of mind in that! It also frees up cash that you can use for other things, like home improvements, travel, or splurging on your grandkids.
How property charges get paid
Many people try to compare a LESA to an escrow account on a traditional forward mortgage, but they don’t work the same way. The lender isn’t collecting cash in a LESA for purposes of paying property charges. The lender is simply setting aside a portion of your reverse mortgage proceeds into a line of credit that is used to pay the property charges automatically when they come due.