Does the Escrow Rule Apply to Reverse Mortgages?
Explore the unique way reverse mortgages handle property charges, a system that differs from the standard escrow rule and can affect your loan proceeds.
A reverse mortgage allows homeowners, typically aged 62 or older, to convert a portion of their home equity into cash. Unlike a traditional mortgage where the borrower makes monthly payments to the lender, with a reverse mortgage, the lender makes payments to the borrower. An escrow account is a separate account held by a mortgage lender to pay property-related expenses, such as property taxes and homeowners insurance, on behalf of the borrower.
The TILA Escrow Rule Exemption for Reverse Mortgages
The Truth in Lending Act (TILA), implemented by Regulation Z, establishes consumer protection standards for the lending industry. One provision requires lenders to create escrow accounts for certain higher-priced mortgage loans to ensure funds are available for property taxes and insurance premiums. These escrow accounts are a standard feature in the forward mortgage market.
However, the framework under TILA includes specific exemptions. The Dodd-Frank Wall Street Reform and Consumer Protection Act amended TILA to explicitly exclude reverse mortgage transactions from this mandatory escrow requirement. This means that under federal law, lenders are not obligated to establish a traditional escrow account for a reverse mortgage as they would for a qualifying forward mortgage.
Homeowner Responsibilities for Property Charges
Despite the federal exemption, the responsibility for paying property charges remains with the homeowner. As a condition of the reverse mortgage, the borrower must stay current on all property-related expenses, which include:
- Local and state property taxes
- Homeowners insurance
- Flood insurance, where applicable
- Homeowners association (HOA) fees
Failure to meet these financial obligations has serious consequences. The loan agreement specifies that non-payment of property taxes or insurance premiums constitutes a default, which can make the loan balance due in full. If the borrower cannot pay the outstanding charges, the lender has the right to initiate foreclosure proceedings.
Without a lender-managed account, the borrower must budget and make timely payments directly to the tax authority and insurance provider to prevent a loan default.
Understanding the Life Expectancy Set-Aside (LESA)
To address the risk of default on property charges, the reverse mortgage industry uses a mechanism known as the Life Expectancy Set-Aside (LESA). While not an escrow account under the TILA definition, a LESA functions in a similar capacity. It is a portion of the reverse mortgage proceeds reserved to cover future property tax and homeowners insurance payments for the borrower’s expected lifespan.
The requirement for a LESA is determined through a mandatory financial assessment during the loan application process. Lenders evaluate the applicant’s credit history, income, and ability to meet their financial obligations. If the assessment indicates a higher risk that the borrower may struggle to pay property charges, the lender will require a LESA as a condition of loan approval.
The funds for the LESA are not an out-of-pocket expense. Instead, the necessary amount is withheld from the total available loan proceeds, which reduces the amount of cash the borrower can draw. The lender or loan servicer then manages the LESA funds, disbursing payments for taxes and insurance on the borrower’s behalf.
In some cases, a borrower who is not required to have a LESA may voluntarily opt to establish one. This can provide peace of mind and simplify budgeting by having the servicer manage the property charge payments, mirroring the convenience of a traditional escrow account.