One of the reasons why reverse mortgages are an attractive option for qualified older homeowners is that the ongoing financial requirements essentially are limited to maintaining the home in good condition and paying homeowners insurance and property tax bills.
If borrowers are unable or unwilling to meet those requirements, they still may be able to get a home equity conversion mortgage — the most common type of reverse mortgage — by adding a life expectancy set-aside, or LESA, to it.
A LESA works like an escrow account, with the lender earmarking a portion of the proceeds from the reverse mortgage to pay property charges. The minimum required amount for a LESA is calculated based on current property costs, along with an estimate of how long the owner is expected to live in the home.
A LESA relieves the borrower of the responsibility to pay those bills. The trade-off is they will receive less of the equity they’re borrowing as cash.
Knowing how a LESA works and the implications of using one are important steps in deciding to get a reverse mortgage:
- What Is a LESA?
- Who Is Eligible for a LESA?
- What Are the Benefits of a LESA?
- What Are the Drawbacks of a LESA?
- LESA Reverse Mortgage FAQ
- The Bottom Line on LESA Benefits for Reverse Mortgage Borrowers
What Is a LESA?
A life expectancy set-aside is an account into which the lender deposits part of the proceeds from a reverse mortgage and uses it to pay property costs, such as:
- Homeowners insurance and flood insurance.
- Property taxes and other taxes.
- Homeowners association fees or planned unit development fees.
How does a LESA work?
Say a borrower owns a home worth $500,000, and takes out a reverse mortgage for 50% of their equity — which is $250,000 — and chooses a LESA to pay their property charges. If the LESA reverse mortgage formula determines they need $50,000 to pay their property charges over the estimated life of the loan, that sum would be set aside from the total loan amount. The maximum amount that the borrower could receive as cash would be $200,000.
How is a LESA calculated?
Lenders use a formula required by the U.S. Department of Housing and Urban Development to calculate the LESA reverse mortgage amount.
The formula looks like this:
LESA = (PC ÷ 12) × {(1 + C)M + 1 − (1 + C)} ÷ {C × (1 + C)M}
In this equation, PC is the annual property charge for taxes and insurance; M is the borrower’s life expectancy in months, based on government data; and C is the monthly compounding rate of the loan, which is the interest rate on the loan plus the monthly mortgage insurance premium. The age of the youngest borrower on the mortgage is used for this calculation.
For example, if a borrower owns a home and typically pays $10,000 for taxes and insurance each year, their life expectancy is estimated at 15 years, and the compounding rate of their loan is 0.5%, the LESA formula would look like this:
LESA = (10,000 ÷ 12) × {(1 + 0.005)180 + 1 − (1 + 0.005)} ÷ {0.005 × (1 + 0.005)180-}
That works out to $99,225.35, which is the minimum amount required for a LESA that would be deducted from the principal on an HECM in this case.
Who Is Eligible for a LESA?
As part of the underwriting process for an HECM, the lender reviews the borrower’s finances and credit score. A reverse mortgage is a loan, so good credit is important to the process.
To qualify for an HECM, homeowners must:
- Be at least 62 years old.
- Live in the home as their primary residence.
- Own significant equity in their home, usually at least 50%.
- Be current on property taxes and have no tax liens or wage garnishments within the past two years.
- Have homeowners insurance in place for at least 90 days before applying.
- Have satisfactory credit.
- Meet with a government counselor.
It’s possible to meet those requirements with a credit history that lenders view as risky. In that case, the lender may require the borrower to have a LESA.
When is a LESA required?
According to HUD, a LESA is required for reverse mortgages where “the mortgagor has not demonstrated the willingness to meet his or her financial obligations and no extenuating circumstances can be documented.”Department of Housing and Urban Development (2016)
Lenders can make this judgment based on factors like the borrower’s credit score, accounts in collection or charged off, judgments against the borrower, and delinquencies.
Borrowers who aren’t required to have a LESA still may choose to use one.
What Are the Benefits of a LESA?
There are a few benefits to having a LESA for your reverse mortgage.
- Easier to get a reverse mortgage. Without a LESA, a borrower with poor credit would be a higher risk for lenders and less likely to qualify for a reverse mortgage.
- Reduces the risk of default. One way to default on a reverse mortgage is to fail to pay property taxes or homeowners insurance. A LESA assures that these bills will be paid on time and in full, and reduces the borrower’s risk of losing their home.
- Offers peace of mind. Because the LESA pays your property taxes and insurance, you don’t have to worry about covering these bills.
What Are the Drawbacks of a LESA?
There are some downsides to having a LESA as part of your reverse mortgage.
- LESA funds come out of your loan amount. The LESA cash balance is carved out of your total loan amount, meaning there’s less available for other purposes.
- You can run out of funds. If you live in the home longer than expected, there’s a chance that the funds in your LESA will run out. “If you do exceed your expected life span, you would now have to make the payments for these yourself,” says Robert Scott, founder of Sell Land, a St. Louis-based real estate company. If you’re not prepared, you could face high costs you can’t afford, and may need to sell your home to pay off the reverse mortgage.
- LESA minimums are nonnegotiable. Since they are calculated by a government-required formula, the borrower has no say in how much they will be required to put into a LESA.
LESA Reverse Mortgage FAQ
LESAs are complicated, so it’s important to make sure you understand how they work.
LESAs are required for borrowers who have shown a history of struggling to pay their debts and other bills. If you are in a good financial situation and have strong credit, a LESA isn’t required, but you still have the option of using one.
If you live in the home long enough, your LESA could run out of money. If that happens, you’ll have to take over the responsibility of paying property taxes and homeowners insurance.
Once the loan is in place, you cannot get rid of the LESA without repaying the loan.
The Bottom Line on LESA Benefits for Reverse Mortgage Borrowers
A life expectancy set-aside can give homeowners and lenders peace of mind that property charges will be paid with a reverse mortgage. The LESA will take care of property tax and insurance costs, meaning you don’t have to worry about covering those expenses. It also saves you the headache of remembering to make the payments. Even if your lender doesn’t require a LESA, you could consider adding one if you decide a reverse mortgage is right for you.
