496: Is it Difficult to Get a Mortgage When you are Retired?

SHOW NOTES FOR EPISODE 496: IS IT DIFFICULT TO GET A MORTGAGE WHEN YOU ARE RETIRED?

Real estate investing is a powerful strategy to generate cash flow, build wealth and create a legacy in retirement.  However, some people think it’s difficult to qualify for a mortgage as a retiree without W-2 employee income.  In today’s podcast, Bill addresses this subject, the truths and fallacies and the strategies retirees can use to apply and get approved for mortgages to build a rental property portfolio.

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Is it Difficult to Get a Mortgage When You are Retired?

Intro

1. So why am I talking about getting a mortgage pre- or post retirement?

Whether you are approaching retirement or already retired, you may be wondering what to do with your existing mortgage or mortgages for your rental properties

• It could be for your existing home or your existing rental properties
  • It you have not already paid off your mortgage, you may be wondering whether you should I pay off your personal home mortgage before you retire
• If you have rental properties
  • Should I pay off my existing rental property mortgage, before buying another
  • Should I accelerate my pay-off
• Or, if you want to purchase rental properties to generate cashflow
  • Should I buy all properties with cash or take out a mortgage

Approaching Retirement

• Pondering the sale of your existing home
  • To pay-off mortgage to reduce retirement expenses
  • Maybe you just want to downsize
    • Family’s gone
    • Don’t want to mess with the upkeep
    • Want to travel, spend time with grandkids, etc
  • Maybe you want to relocate to another area where there’s a lower cost of living (53% of Californians want to move out of state!)
  • Cash out to add to or create a nest egg, invest in rental properties or other investments
• Or maybe you want to hold on to your house as your “personal bank” and take out a HELOC or line of credit to draw upon to invest or for expenses
• Considering investing
  • Using excess cash after sale to buy a property
    • Use cash to pay in full
    • Or for leverage as down payment

If you’re Already Retired

• Pondering the sale of your existing home – downsizing
• Considering investing
  • Using excess cash after sale to buy a property
    • Pay in full
    • As down payment

My Personal Experience

• Was debt free for 20 years prior to becoming a real estate investor
• I had an aggressive plan – 1,000 doors in 6 years
• To achieve my plan, I needed to leverage
  • Everyone thinks Leverage = Debt
    • That’s not necessarily the case
    • To access equity, I could either sell or borrow
    • Leverage Through Equity Play – Flipping or Wholesaling or Buy ‘n Hold
      • Easiest in economic recovery
      • Bought duplex for $55K, it was worth $200K 1.5 years later
        • If I would have sold, I could have maybe bought a fourplex for $145K (my goals was to double the size of my portfolio each year)
        • Found 22-unit for $350K
      • I knew I would need to eventually take out mortgages
      • It killed me to go into debt but I made the decision to take on debt
        • Had to start from scratch
          • Had old AMEX card
          • Car loan
          • Mortgage
          • Commercial loan
        • Do I regret?
          • I still hate the debt – even though it’s what Robert Kiyosaki calls “good debt” – I still hate owing anyone
          • On the positive side, I haven’t paid taxes since I started investing because of the great write-offs
          • When you get into syndication, it’s still debt, although people call it equity – I still owe people, even though they’re technically investors and not lenders
          • Could I have built it without debt?
            • Yes, but it would have taken much longer
            • Prices were not increasing like when I first started
            • I also was in other markets and assets that were slow and steady – not emerging
            • Yes, my properties all went up in value but some soared and some inched
          • I didn’t get the best rates because I did everything on my own, in the beginning, without investors. Why?
            • I didn’t have W2 Income

Fear of Not Getting a Mortgage in Retirement

I frequently hear stories of upcoming retirees who, planning to move after retirement, locate a new home and take out the mortgage before retirement – because they think once they are retired they won’t be able to get a new mortgage.

Or, following conventional wisdom, some homeowners may feel that they should pay off their mortgage before they retire so they won’t have to make a large monthly payment on a smaller income.

And yet, some retirees might find it more beneficial tax-wise to keep making that mortgage payment.

Consider a couple who sells their home to downsize and receives a chunk of cash from years of building up equity. If they do not use that equity to pay cash for the new home, they suddenly have significantly more liquidity. They can add that money to their nest egg, invest it, and earn returns that may be higher than what they will pay in mortgage interest. They can then gradually withdraw their earnings for additional retirement income.

The big question is this: Is it possible to qualify for a mortgage after retirement?

Financial planners and mortgage lenders say, yes. So does Fannie Mae and Freddie Mac, two of the biggest players in the mortgage market. They are government-sponsored enterprises that buy mortgages from banks and home financing companies, provided those mortgages meet certain standards.

Under the Equal Credit Opportunity Act, lenders cannot discriminate against borrowers based on age — retired borrowers, like working borrowers, simply need to show that they have good credit, not too much debt, and enough ongoing income to repay the mortgage.

Demonstrating proof of income may be different than it would be for working borrowers, but retirees who qualify can even take out a 30-year mortgage; lenders cannot base their decisions on an applicant’s life expectancy.

Retirees and near-retirees interested in qualifying for a mortgage after retirement should understand how lenders will evaluate them.

Let’s look at what mortgage qualification requirements for retirees:

Income

For any mortgage, Fannie Mae instructs lenders to look for income that is “stable, predictable, and likely to continue.”  For borrowers who work and earn a salary or regular wage, that requirement is easy to meet. They can provide paystubs and W-2s to document their income history, and they do not need to prove that their income is expected to continue at the same level for the foreseeable future.

But getting a mortgage in retirement is not so easy for retirees. Fannie Mae considers distributions from 401(k)s, IRAs, or Keogh retirement accounts to have a defined expiration date because they involve depletion of an asset. Borrowers who derive income from such sources must document that it is expected to continue for at least three years after the date of their mortgage application. Lenders can only use 70 percent of the value of those accounts to determine how many distributions remain if the accounts consist of stocks, bonds, or mutual funds, since those assets can be volatile. The retiree must also have unrestricted access to these accounts without penalty: for example, individuals usually cannot withdraw money from 401(k) accounts before age 59 ½ without penalty. Freddie Mac has similar requirements.

Social Security income that a borrower is drawing on his or her own work record is considered income that does not have a defined expiration date, but income being drawn on a family member’s record, such as survivor benefits or spousal benefits, must be shown to be payable for at least three years from the mortgage application date. Retirees can document this income using their award letter from the Social Security Administration and/or proof of current receipt.

If a borrower does not have to pay taxes on certain income, then lenders can increase that amount by 25 percent (they call this “grossing up”) when calculating qualifying income since other qualifying income sources are considered on a pretax basis.

Just because a lender is allowed to gross up income does not mean they have to, said Casey Fleming, author of “ The Loan Guide: How to Get the Best Possible Mortgage” and a mortgage advisor with C2 Financial Corporation in San Jose, California.  Some lenders will increase qualifying income by a smaller amount, such as 15 percent, while others will not do it at all.

Corporate or government retirement or pension income is not considered to have a defined expiration date, nor are part-time job earnings, rental income, or self-employment income.  Interest and dividend income falls into this category, too, unless the underlying asset that produces that income will be depleted.

Annuity income can be used to qualify as long as the borrower can document that it is expected to continue for at least three years.

Regardless of whether the income has a defined expiration date, lenders require retirees to document the regular and continued receipt of their qualifying income using one or more of the following: letters from the organizations providing the income, copies of retirement award letters, copies of signed federal income tax returns, IRS W-2 or 1099 forms, or proof of current receipt. Freddie Mac’s requirements to document retirement income are similar to Fannie Mae’s.

Borrowers who only take sporadic withdrawals from retirement accounts rather than regular withdrawals might have trouble qualifying. But the solution may be easy as long as there is no time crunch to get a mortgage: just start taking regular withdrawals for two months or more before applying for a loan.

Married couples applying for a loan together should consider how their spouse’s death would affect their ability to keep paying the mortgage.  Would they lose a significant amount of pension or Social Security income that they are using to qualify?  Lenders, however, cannot address this matter in the loan application.

Indeed, lenders would be very hesitant to even broach the subject.

Mortgage qualification requirements for retirees:

Let’s look at Assets

Retirees often have significant assets, but limited income, so Fannie and Freddie have found ways to help retirees qualify based on their assets.

Fannie Mae lets lenders use a borrower’s retirement assets in one of two ways to help them qualify for a mortgage.  If the borrower is already using the asset, such as a 401(k), to receive retirement income, the borrower must demonstrate that they will continue to receive regular income from that asset for at least three years.  If the borrower is not already using the asset, the lender can compute the income stream that asset could offer.

Similarly, Freddie Mac changed its lending guidelines in the spring of 2011 to make it easier for borrowers to qualify for a mortgage when they have limited incomes but substantial assets. The rule allows lenders to consider IRAs, 401(k)s, lump sum retirement account distributions, and proceeds from the sale of a business to qualify for a mortgage.  These assets must be “entirely accessible to the borrower, not subject to a withdrawal penalty, and not be currently used as a source of income.” IRA and 401(k) assets must also be fully vested.

Lenders sometimes call this an “asset depletion loan” or “asset based loan,” though it is not a separate loan type, but a way of qualifying.  Borrowers can still count income from other sources when they use assets to help them qualify.

For example, suppose John has $1,000,000 in his 401(k) and he has not touched it.  He is not yet 70½, the age at which the IRS requires account owners to start taking required minimum distributions from 401(k)s.  He is living off Social Security and the income from a Roth IRA.

A lender could use 70 percent of his 401(k) balance (to account for market swings that could lower the account’s value), or $700,000, minus his down payment (let’s call it $50,000) and closing costs (let’s say those are $20,000) to arrive at $630,000, an amount that he could be expected to use to gradually pay for his mortgage over the next 360 months, or 30 years. That would give him $1,750 a month to put toward a housing payment.

The lender does not have to subtract closing costs if the borrower pays them from a different account; if John did that, he would have $1,805 in qualifying monthly income to put toward a housing payment.

Unfortunately, even if John wanted a 15-year mortgage, the lender would still have to divide his 401(k) balance by 360, not 180, because that is what Freddie Mac’s rules require.

John does not actually have to start dipping into his 401(k) to pay the mortgage, but this calculation shows lenders that he could rely on his 401(k) to pay the mortgage if needed to. He could use the asset depletion method from his untouched 401(k) combined with the income he is already receiving from Social Security and his Roth IRA to qualify and borrow as much as possible.

Fannie Mae also allows borrowers to use vested assets from retirement accounts for the down payment, closing costs, and reserves.

Retirement assets that can only be accessed with a penalty, like 401(k) assets before age 59 ½, can’t be used for income qualification.  They can be counted toward reserve requirements, however.

They don’t want you to be flat broke and busted when you close escrow, so you have to have reserves—typically, at least three times the total monthly housing payment.  If you don’t have enough in liquid assets, the lender can usually use about 60 percent of retirement reserves.  The 60 percent accounts for penalties and taxes. The exact amount allowed, if any, is up to the lender.

Freddie Mac allows the cash value of a life insurance policy to be counted as a qualifying asset, but if the money is needed to pay for the mortgage or closing costs, the cash value must be liquidated.¹  Fannie Mae allows the net proceeds from a loan against a policy’s cash value or the surrender value of a life insurance policy to be used for a down payment, closing costs, and reserves.  Any repayment obligations to the policy will be factored into qualifying the borrower as an additional debt obligation in the debt-to-income ratio or by subtracting them from the borrower’s financial reserves.

Of course, using the cash value of a permanent life insurance policy could lead to a reduction in the policy’s value and its death benefit.  It can also lead to the policy lapsing altogether and a tax bill under some circumstances.

Finding the right lender

Most mortgage lenders at banks sell their loans to Freddie Mac or Fannie Mae. They all pretty much follow the same rules.  But not all lenders are experienced in issuing mortgages to retirees.

Before spending too much time with a lender, retiree borrowers can ask a few screening questions to determine if they have the willingness and the know-how to handle their application.

Just ask the lender how they qualify retirement income and how they calculate qualifying income from assets.

Summary

Buying a home with a mortgage as a retiree can be more difficult than buying a home with standard employment income.  Most lenders consider pension, Social Security and investment income as your regular income.  You may also be able to include your annuity, survivor or spousal benefits and retirement account income as long as you can prove it’ll continue for at least 3 years.  And your assets can contribute to your ability to get a loan.

You can make up for a lower income with a better DTI ratio and credit score.  You may also have an easier time getting a mortgage loan for a primary residence over a second home or rental property.

Well, that’s it for today!

Podcast References:

https://www.thebalance.com/how-to-get-a-mortgage-once-you-are-retired-2388738

https://blog.massmutual.com/post/how-to-get-a-mortgage-during-retirement

https://www.rocketmortgage.com/learn/how-lenders-view-retirement-income

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