After retiring, can one obtain a mortgage and is it advisable?
As you shift from a consistent paycheck to a combination of set and fluctuating income along with a new way of living, acquiring a large debt might not be the easiest choice. This is especially accurate now that mortgage rates hover around 7% and house prices continue to grow.
Jim Stork, a financial planner based in Illinois, stated, "Any time you take on debt, you augment the risks in your situation."
In 2021, over a third (35%) of homebuyers fell between the ages of 59 and 98. Within that category, many financed their acquisitions.
The decision to obtain a mortgage depends on various factors, including proving to a lender that you're a responsible borrower, and your own perspective on debt and the continuous costs of maintaining a home.
How old you are doesn't affect your chances of getting a mortgage, but your income will
If you are upset that you may be seen less favorably by mortgage lenders due to reaching retirement age, it is illegal to deny someone a mortgage due to their age.
Instead, lenders are most focused on your ability to repay the mortgage with your different forms of income beyond a typical paycheck.
Melissa Cohn, regional vice president at William Raveis Mortgage, highlighted, "When you qualify for a mortgage, it's all based on your income."
Of course, any debt you hold that reduces your income will also be considered.
The income sources lenders consider, outside of a regular salary, include: Social Security benefits, pension or annuity income, spousal benefits, disability payments, interest and dividends, and your 401(k) or IRA.
If part of your income is exempt from taxation, the lender may consider this income to be worth 25% more. For example, if you receive a $1,500 monthly Social Security benefit with 15% of it being tax-free, that equates to an additional $56 ($1,500 x 15%) in qualifying Social Security income ($1,500 + $56 = $1,556).
If you wish to utilize your savings, you can employ a couple of methods to estimate the income these assets would provide. One option is the asset depletion approach, in which your eligible assets are divided by the loan term. For a 30-year mortgage, that would be 360 months. If your IRA is valued at $700,000, this equates to a monthly income of $1,944 ($700,000/360). "You don't necessarily have to withdraw the money - but you can use your assets [to apply for a mortgage] as if you were going to take the withdrawal," said Cohn.
An additional choice: If you are at least 59-1/2, you can start taking monthly distributions from your IRA or 401(k) (if your plan rules allow it) and the lender will consider that as income if you demonstrate you have sufficient funds to maintain those monthly distributions for three years. Following your home purchase, Cohn explained, you can decrease or halt distributions if you opt. This holds true unless you reach your 70s, when the IRS mandates annual distributions, noted Mark Luscombe, a principal analyst at Wolters, Kluwer Tax & Accounting.
Loaded with debt?
Lenders will also examine your debt-to-income ratio, as borrowing potential is not defined solely by income.
Your debt-to-income ratio is made up of your anticipated mortgage payment combined with any remaining credit card, student loan, automobile loan, or other debt you might possess. Generally speaking, your DTI ratio for conventional loans can reach up to 50%, but a reduced ratio of 43%-45% is expected for jumbo loans, explained Cohn. A jumbo loan exceeds the conforming loan limits in the location you want to purchase.
Yet, it's ideal for your debt burden to be below these top limits, both for the lender's peace of mind and your own. And, the higher your credit score, the more favorable the mortgage interest rate you can obtain.
Before requesting a mortgage, consider your anticipated income and expenditures in retirement
Before applying for a mortgage, familiarize yourself with your expected retirement income and expenses.
Certified financial planner Lori Trawinski, AARP's director of finance and employment, emphasized, "The majority [of retirees] notice a decrease in income."
Although some costs may reduce, like career-related expenses such as commuting, others could escalate over time, like medical costs, property taxes, home insurance, and utilities.
While you can downsize and relocate to a lower-cost area, if you remain where you worked, your expenses are likely to grow.
Trawinski also mentioned the importance of evaluating the impact of a spouse's death on your household income. This is essential in understanding your ability to manage a mortgage. She highlighted, "People often overlook the possibility of losing one half of their income due to the passing away of a spouse."
If you're considering a move to a new location, renting for a while could give you a better insight into the living costs and help you determine if it's a suitable place to settle in. Stork elaborated, "Florida's August heat might not be as enjoyable as its January sunshine."
It's crucial to be aware of your financial commitments, particularly during retirement. Taking on unnecessary debts is not ideal, as the mortgage repayment remains constant while the market conditions, investment returns, and health requirements can vary. At least, Stork advised, try to put down a substantial amount to avoid paying private mortgage insurance.
Another factor to consider is the ability to manage and pay for house maintenance. Stork estimated that the annual maintenance could be approximately 2% of your home's value, amounting to $10,000 for a $500,000 house. This is crucial for preserving the value of your property if you ever decide to sell it.
Furthermore, she suggested comparing your mortgage interest rate to the potential returns on your investments. The choice of getting a mortgage was more straightforward when rates were historically low (around 3%), and your investments were yielding more. However, with today's high mortgage rates, Stork emphasized it becomes a more complex decision, especially for conservative investors. "If your CDs are returning 4% and the mortgage costs 7%, you'll end up losing money every day on that decision," she elaborated.
To gain an accurate understanding of what is financially sensible, Stork advised comparing all associated costs, including mortgage payments and investment returns, on an after-tax basis.
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Despite the challenges posed by high mortgage rates and growing house prices, some retirees have successfully obtained mortgages in recent years. For instance, over a third of homebuyers in 2021 were aged between 59 and 98, many of whom financed their acquisitions.
The success of obtaining a mortgage, even in retirement, largely depends on proving to lenders that you have a steady income stream to cover the mortgage payments. This income can come from various sources such as Social Security benefits, pension or annuity income, spousal benefits, disability payments, interest and dividends, and your 401(k) or IRA.
