Retirement and looking for a place to live? How to finance your next home purchase
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Retirees considering moving to buy a home may want to consider how they would finance the purchase.
Seniors can find it difficult to get a mortgage in retirement, said Al Bingham, a mortgage loan officer at Momentum Loans in Sandy, Utah. Not only are lenders even more cautious about lending during the pandemic, retirees have generally left steady paychecks.
“They can have a lot of money, but they can have very little income and struggle to qualify for a mortgage,” said Bingham. “It frustrates a lot of them.”
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And while interest rates are still very low, they have crept up. The average interest rate for a 30-year mortgage is 3.25%, while it is around 2.5% for a 15-year fixed-rate mortgage, according to Bankrate.
Combined with soaring house prices and limited inventory, the situation could be even more difficult for retirees, Bingham said. This means that it can be worthwhile to strategize and plan with foresight.
Of course, the typical aspects of qualifying for a mortgage – such as good credit and not overly high monthly debt – would also apply.
The details depend on the lender and the type of mortgage you are looking for. Loans backed by Fannie Mae and Freddie Mac have requirements that lenders must adhere to, while private mortgage lenders may have their own standards.
Qualification based on income
Retirees most commonly get a mortgage by qualifying based on income, said certified financial planner Daniel Graff, principal and relationship manager at Sullivan, Bruyette, Speros & Blayney in McLean, Virginia.
Lenders typically review your last two years’ tax returns to see what that amount is. This can include, for example, social security, retirement income, dividends, and interest.
However, your taxable income may not be enough to qualify for the loan alone. This is where a retirement account like a 401 (k) plan or an individual retirement account can come into play.
You can have a lot of money, but you can have very little income and struggle to qualify for a mortgage.
Mortgage Loan Officer at Momentum Loans
The idea is that to qualify for the mortgage, even if you don’t really need the money, you are making distributions. As long as you are at least 59½ years old, you can tap your IRA or 401 (k) plan without paying a 10% early withdrawal penalty.
In accordance with the rollover rules that apply to retirement accounts, you can repay the money within 60 days without the distributions being taxable. However, beyond this period, the withdrawals would be blocked and you would owe income taxes on the money.
In the meantime, the lender would see the earnings on your bank statements, where the money came from and when it came into your account.
Graff said he helped with two customer mortgages last year that had two months of payouts from an IRA so they could qualify and then return them under the 60-day rollover rule.
However, he said, “My mortgage lenders tell me they are making the historical review a little stricter, which could limit that possibility in the future.”
In addition to verifying required income, lenders want to be sure that the payouts can continue for at least three more years, Graff said.
Alternatively, you may be able to qualify for a mortgage based on your assets in a brokerage account or an IRA. Essentially, the lender applies a formula to the money in your account – usually using 70% of the account value – to determine if it can stretch out long enough to cover mortgage payments for the life of the loan.
“In this scenario, the underwriter is not looking directly for a taxable transfer from an IRA to a bank, but rather for a statement of assets that will make it possible [the lender] to be sure that a certain amount can be withdrawn every month, “said Graff.
There are a few alternatives that are similar but have subtle differences.
The first option is to take out what is known as a margin loan on your brokerage account to fund your down payment or part of the purchase. Basically, brokerage firms can lend you money against the value of your portfolio – called margin loans – whether you are going to use the money to buy stocks or something that has nothing to do with investing.
While such loans come with the risk of a “margin call” – you may be asked to add money to your brokerage account if the value falls below a certain amount – the interest rates on margin loans are generally cheaper than mortgages or mortgages other types of borrowed money.
“Right now we’re seeing some rates at 1.75%,” said Graff.
While it would be important to cap the loan so you have less risk of a margin call, this is a way to avoid selling assets in the account and paying taxes on profits if that were the alternative. And the loan can stay in place until you pay it off (as opposed to a set deadline).
“What I see is a combination of margin credit and traditional funding,” Graff said.
The other option is to “mortgage assets”. This includes taking out a loan on your brokerage account and the assets are used as collateral. However, unlike margin loans, you cannot use the money to purchase securities. There is also a fixed term for these loans.
For example, you may be able to borrow from Schwab up to 70% of the value of the eligible assets pledged as collateral. The longest term for such a loan is five years.
“You could use this loan almost as a bridge loan and plan more precisely how to prove income to the bank,” Graff said.
It should be noted that the interest paid on these loans is often deductible from portfolio income (interest and dividends).
“It’s not deductible on Schedule A like a traditional mortgage, but in many situations the tax benefits can be similar,” Graff said.
He added, however, that you should consult a tax advisor to fully understand your options.