Conventional wisdom notes that as people get older or near retirement, they try to retire without a mortgage payment that drains their monthly income. This wisdom is based on the logic that the earning power of those in retirement tends to diminish. By not having a monthly mortgage payment while retired, one will undoubtedly find it easier to keep to a budget.
However, there are times when retired individuals have found great benefit by securing or maintaining a mortgage while retired.
Consider this couple…
Mr. and Mrs. Whitmore just recently sold their home after owning it for 32 years to downsize and move to a warmer climate near their grandchildren. Mrs. Whitmore wants to spend more time outdoors.
At closing, the Whitmores receive a substantial chunk of cash after leaving the equity untouched in their family home for more than three decades. At this point, the Whitmores, with cash in hand have several options from which to choose:
- The Whitmores could use the money from the sale of their home to qualify for a new mortgage if needed.
- The Whitmores could invest the money from the sale of their home. In this approach, the Whitemores could let the investment appreciate (for whatever amount of time they had). Then, when needed, they could use this asset to generate a rate of return (through distributions) that would likely exceed the interest rate costs on a new mortgage – especially in today’s historic, low-interest-rate environment.
The second option noted above allows Mr. and Mrs. Whitmore to supplement their retirement income by gradually withdrawing the earnings and original investment (from the assets received from the sale of their previous home). In this way, the Whitmores have added to their retirement income by using the cash generated from the home’s sale.
While this is just a basic example of the benefits offered to those who are retired with a mortgage, it is also an important reminder of your need to know – if and how a lender will approve your mortgage application as a retired person. The narrative that follows analyzes how a mortgage underwriter evaluates and verifies the various sources of income typically received by those in retirement.
Can You Get a Mortgage If You Live Off Retirement Income?
The short answer is yes.
The reality is, lending institutions are prohibited from discriminating against any borrower based strictly on their age. It is a violation of lending law to make a credit decision based on the borrower’s life expectancy.
ECOA, the Equal Credit Opportunity Act, disallows any mortgage lender from discriminating based on several federally defined classes, of which age is one. The rest of the protected classes are as follows –
- Religion
- Race
- National Origin
- Color
- Sex
- Marital Status
Consider this question: Can a 91-year-old borrower – who otherwise qualifies for a mortgage – be denied a 30-year mortgage because of their age?
A borrower who is 91 years old – who otherwise qualifies for the mortgage to which they applied, cannot be denied a 30-year mortgage. It is irrelevant that the odds are that the borrower will be alive for the duration of the mortgage.
So, retired individuals only need to qualify for a mortgage based on the standard underwriting questions:
- Will the borrower repay the loan as agreed?
- This can be determined by analyzing the borrower’s credit and debt repayment history.
- Do the borrower manage their use of credit judiciously?
- Can the borrower repay the loan as agreed?
- This answer can be determined by analyzing the borrower’s employment history and their ability to maintain a consistent income stream.
- Do the borrower change employers frequently?
- If the borrower is unwilling or unable to make the agreed-upon monthly payments, what is the lender’s collateral for repayment?
- This answer can be determined by analyzing the appraisal report.
- Will the lender be able to recoup their losses from a non-performing mortgage by foreclosing on the subject property and selling it at auction?
Borrowers applying for a mortgage who have retired will still be required to qualify for the mortgage; however, the paperwork necessary to document a retired person’s income may differ from those mortgage applicants who are still working.
So, if you are retired (or are planning on retiring shortly), it is essential to understand how a lender will require you to document your income when applying for a mortgage loan.
Mortgage Income Qualifications for Retirees
Mortgage underwriters base their underwriting approvals on an income stream that is:
- Predictable.
- Stable.
- Calculable.
- Likely to continue.
Working borrowers typically provide paystubs, W2s, or 1040 tax returns to document the income they receive from employment. Inherent in a working borrower’s underwriting analysis is the fact that the income and employment are likely to continue at the same or similar level, at least for the foreseeable future.
This is where the road divides and the income documentation for a retired borrower differs from that of a working borrower.
Distributions/Income from IRAs, 401(k)s, & Keogh Retirement Accounts
The mortgage giants like Fannie Mae and Freddie Mac view retirement account distributions as having a defined date of expiration. This is because, as an asset, it will eventually be depleted.
As such, retired folks must document that the income they are receiving from the distribution of retirement assets:
- Has an expected minimum distribution of at least 36 months from the date the borrowers applied for the mortgage loan.
- Is an unencumbered asset that is accessible without a penalty. For most retirement accounts, distributions can occur without penalty after the age of 59 1/2.
It is noted that lenders will calculate the expected retirement income distributions based on 70% of the account’s value. This is because most retirement accounts fluctuate somewhat in reaction to overall economic and market conditions.
Social Security Income
Social security income is documented differently than those distributions received from an IRA, Keogh or 401(k) retirement account. This is because social security income – income that is being received by the person who has earned it – is viewed as existing without a defined expiration date.
However, spousal or survivor social income benefits must be documented to show that the social security benefits will continue for at least 36 months, starting from the mortgage application date.
Those individuals receiving social security receive an ‘award letter’ before the monthly payments begin. This award letter easily documents the amount of social security received by a borrower.
Documenting Non-Taxable Income
Borrowers who receive income – be it retirement income or any other income – that is earned tax-free should be aware that mortgage underwriters can increase that non-taxable income by 25% (this number may change based on the underwriter or lending institution) to calculate a borrower’s qualifying income.
This technique is known as grossing up. An underwriter grosses up non-taxable income because the mortgage qualification process should be based on income calculations that include pretax income.
Non-Taxable Income Examples
- Bonds that are issued by local, city, or state governments are typically tax-free at the federal level.
- Municipal bonds are typically tax-free in the state in which the bond was issued.
Other Types of Retirement Income
Pensions from corporations or governments are considered to be income without an expiration date. This is also true of income received from:
- Part-time jobs.
- Rental properties.
- Interest and dividends – unless the asset underlying the income has the potential to become depleted over time.
Like IRAs and Keoghs, annuity income must be documented to show that the income stream will continue for a minimum of 36 months.
If you are a borrower who only withdraws from your retirement account sporadically, it might be difficult to qualify for a mortgage. However, if you have flexibility – in terms of time, you can sidestep this pothole by taking regular distributions several months before you submit your mortgage application.
Married couples should factor in what would happen should one of them die. Would the remaining spouse be able to meet the monthly mortgage payments? It is important to understand what would happen should your partner die, but it is noted that this concept can never be a part of an underwriting decision.
Retire Income Qualification Recap
Independent of whether a borrower’s income has an expiration date, mortgage underwriters require income to be documented as follows:
- Retirement Award Letters.
- W2s or 1099s.
- Signed 1040 Tax Returns.
- Retirement Account Statements.
Mortgage Asset Qualifications for Retirees
Most individuals who retire are asset rich and income poor. Underwriters have created ways to analyze assets to help retired borrowers qualify for a mortgage. Fannie Mae allows lending institutions to use assets to calculate a borrower’s retirement income, as follows:
- If a borrower has already begun to receive a regular distribution from a retirement asset like a 401(k), they must evidence that this regular income is expected to continue for a minimum of three years.
- If a borrower has not begun to liquidate this asset, lenders have several methods to calculate the asset’s expected income.
Here is an example of a retirement-account income stream calculation:
Mark, aged 63, has a 401(k) with a balance of $1,000,000. He has not yet begun to take distributions.
An underwriter could use the following analysis to help Mark qualify for a mortgage.
First, reduce the account balance to $700,000 (70% of the total account value) – this accounts for potential market swings over time. Mark needs $70,000 to purchase a house and will take a mortgage for the balance. If Mark took a 30- or 15-year mortgage, the underwriter could conservatively give Mark $1,750 per month in income that could be applied toward the monthly mortgage payment. [$1,000,000/360 (30 years) = $1,750.]
The borrower, in this situation, would be under no obligation to begin to withdraw these funds, but the underwriter’s calculation shows that the money was there if Mark needed it.
Vested assets in retirement accounts are acceptable for use when analyzing the borrower’s cash requirements for:
- The Down Payment.
- The Closing Costs.
- The Required Reserves, among others.
Up until you are 59 1/2, you can only access retirement assets by incurring a penalty. As such, these assets can only be used to meet the reserve requirements of the mortgage. Remember, lenders need to make sure you have some assets (for emergencies, etc.) after you close. This is the reserve requirement, which is generally about three times your total house payment.
If you possess a life insurance policy, most lenders will accept the policy’s cash value as a qualifying asset. However, if these funds are required to close, the policy must be liquidated. In fact, lenders generally allow for the cash or surrender value of a policy to be used for anything the borrower may need if for. As a word of caution, the policy’s value or death benefit may be impacted by the use of its cash value. In some instances, it might even violate the policy, thus canceling it, or generate a tax liability.
Other Lending Options for Retired Folks
If you are a veteran, it may pay to look into the mortgage options offered by the Veterans Administration (VA). VA loans offer a no-down-payment option; however, the VA requires borrowers to pay a funding fee.
The Takeaway
Conventional wisdom aside, the decision to maintain a mortgage when retired is a very personal one. There are times when a retired couple may have no choice, and there are those times when it makes financial sense to maintain a mortgage.
Either way, retired folks have options if they need a mortgage. Once you understand the requirements, documenting the income or assets of those retired is different but no more difficult.
If you’re retired, congratulations!