The housing market may have suffered a tough blow last spring when the global pandemic put buying, selling, and moving on hold, but it has shown incredible resilience since then. Homebuyers and low-interest rates have done wonders in keeping the housing market afloat. So much so, in fact, that 2020 was a record-breaking year for new and existing home sales in the US. Big companies like Zillow expect even bigger growth in 2021 as unrelenting demand pushes home values higher and higher.
So what if you want to take advantage of this low-interest rate environment and refinance, downsize, or move, but you are already retired and do not earn a traditional income? Can you still qualify for a mortgage?
The short answer is yes. Absolutely! But, there are some important considerations to keep in mind as you approach the process. Purchasing in retirement is different than purchasing while you earn a traditional income. The way lenders calculate the terms of your loan will be dependent on the type of income you receive and your debt-to-income (DTI) ratio.
It may be worth noting that age will not play a factor in a lender’s borrowing decision. Under the Equal Credit Opportunity Act, lenders are legally prohibited from discriminating against borrowers based on age. Like working borrowers, retired borrowers simply need to show that they have good credit, a limited amount of debt, and enough ongoing income to repay the mortgage. But, retirees and near-retirees interested in qualifying for a mortgage after retirement need to understand how lenders will evaluate them.
Mortgage Qualification Requirements for Retirees: Income Types
Proving an income when you are working is simple—you collect your W-2’s and paystubs to document your payment history and submit them to the lender. You don’t have to prove that you will be receiving that same income for the foreseeable future.
However, this is the case with retirees. When evaluating a retiree’s income, lenders consider if the sources of income will last. That is, do they have a defined expiration date? Is there a possibility the borrower could spend down all their assets or be denied access to their retirement funds?
Different income sources carry different weight with lenders. According to Fannie Mae, distributions from 401(k)s, IRAs, and retirement accounts have what they call “a defined expiration date” because they involve the depletion of an asset. Individuals claiming income from those sources must be able to prove that they will continue to receive that same income from those sources for at least three years after the date of their mortgage application. The borrower must also have unrestricted access to those accounts without penalty. So if a retiree is under age 59 ½ and is not yet qualified to withdraw funds without penalty, a lender may not consider this a valid source of income until six months after the borrower’s 59th birthday.
Social security income, however, is not seen as having a defined expiration date and can be counted as income. The amount can be proven via your award letter from the Social Security Administration or with current receipts. Defined benefit pension plans, part-time job earnings, rental income, self-employment income, and interest and dividends from investment accounts also count as ordinary income (unless the assets producing that income will be depleted).
Even though demonstrating proof of income may be different for a retiree than for a working borrower, obtaining a new loan is possible.
Drawdown Versus Asset Depletion
There are two common ways lenders evaluate a retiree’s income: (1) on a “drawdown” basis or “asset depletion” basis. The drawdown on assets method is beneficial for individuals who are over age 59 ½ but have not yet started taking SS benefits or receiving pension income. In this scenario, the individual will use bank statements to prove that they are receiving a steady stream of income from other retirement accounts.
For retirees with a large sum of invested assets, the asset depletion method may work best. Here, the lender looks at the individual’s total value of financial assets and subtracts their down payment and closing costs from this number. They then take 70% of this remaining number and divide it by 360 (for a 30-year mortgage) to determine the monthly income of the borrower.
Once an individual’s qualifying income is calculated, the lender will then look at the Debt-to-Income (DTI) ratio.
Understanding Debt to Income Ratio and Housing Expense Ratio
Your debt-to-income ratio, or DTI, plays a large role in whether or not you will qualify for a mortgage. It represents the percentage of your income that goes toward paying your monthly debts. Lenders calculate your debt-to-income ratio by dividing your monthly debt obligations by your pretax, or gross, income. The higher your DTI, the more difficult it may be to obtain a low interest rate.
Housing Costs are also often considered in a lender’s decision-making process. Your housing expenses are calculated by adding together the principal and interest portion of the mortgage with taxes and insurance. Typically, lenders do not like this number to exceed 28% of your total income.
Refinancing in retirement works much the same way. But there are pros and cons to this option. A positive outcome is the possibility of lowering your monthly obligation and reducing total interest owed on a loan you already carry, but this may also mean you have to extend the life of your loan.
If you have significant equity in your home and are considering a cash out refinance, the important thing is to weigh the relative merits of the refinance against the possible outcome to determine if the somewhat lengthy process is truly helping you come out on top in the end.
Applying for a Mortgage
Typically, the old adage was become mortgage free to in retirement, but there are circumstances where it makes sense. When it comes to buying second homes or even refinancing, the decision becomes more nuanced. Always consult with your financial professional before making major decisions such as these.
The housing market is hot right now and many individuals are buying, selling, downsizing, and even refinancing. If you need help deciding the best way to go, we are here to help. Simply schedule a call with your Northstar advisor and we’ll help you assess your options.