Senior dilemma: lots of equity, little income

A common problem among aged homeowners is that they no longer have the income to service their mortgage, and don't have a good way to convert the substantial equity in their house into cash flow. The case below is typical.

"I am a 67-year-old widow with a mortgage of $414,000 on a house valued at $1.25 million. I can no longer afford the mortgage payment and property taxes, but the lender will not discuss modifying my loan contract until I am behind three payments. I don't want to destroy my credit, and have been borrowing from family to stay current. Is there anything else I can do?"

Assuming she wants to remain in the house, a reverse mortgage is the best solution to this problem. A reverse mortgage would allow her to convert the existing mortgage with its accompanying payment obligation into a reverse mortgage with no required monthly payments. Unfortunately, the loan limit on FHA's Home Equity Conversion Mortgage is not high enough to help this borrower, and the private programs with higher loan limits have shut down because of the financial crisis.

In a similar case some years ago, I recommended that the borrower do a cash-out refinance, investing the cash in a mutual fund and drawing cash from the fund monthly to make the mortgage payment. That would work in this case also. For example, if she borrowed $800,000, the cash of $386,000 would cover the payment for at least seven years.

The trouble is that this loan would not meet current underwriting rules, because the payment is too high relative to the borrower's income -- it is not "affordable." Because of the abuses committed during the housing bubble when many houses were sold to people who couldn't afford them, underwriting affordability rules have become extremely rigid. No allowance is made for the situation where the borrower is already in the house and can't afford the payment, and the purpose of the refinance is to allow her to remain in the house for years longer. Applying an affordability rule in this situation is ridiculous.

Still another possible way to deal with the problem is for the lender to simply drop the payment to a level that is affordable to the borrower, adding the unpaid interest to the balance, for a specified number of years. Because the borrower has so much equity in the house, the risk of loss to the lender is negligible. The trouble with this is that it constitutes a modification of the loan contract, and in all probability it will not be considered until the borrower is in default.

In sum, the elderly borrower with little income but a lot of equity is poorly served by our housing finance system. ...CONTINUED

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