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 mortgage.
You don’t have to do it that way. You can get a mortgage once you are retired.
- Mortgage lenders can determine a retiree's income by reviewing withdrawals from retirement accounts or the value of assets and investments.
- You'll need to meet standard debt-to-income and credit score requirements to qualify.
- Your required down payment can vary, depending on the income-verification method used, but expect to put 5% to 30% down.
Determining Income for Retirees
Retirees assume that if they don’t have a paycheck, they won’t qualify for a mortgage, due to lack of income.
In reality, lenders have two methods, described below, that they can use to calculate income for a retiree who is drawing on their assets.
Drawdown From Retirement Method
For retirees who are following a plan where they are now retired but may be delaying the start of Social Security or pension income, the most favorable option is doing to be using a “drawdown on assets” method of determining income. Here’s how it works.
As long as the borrower is age 59 1/2, the lender can use recent withdrawals from retirement accounts as proof of income. For example, assume that recent bank statements show withdrawals of $4,500 per month from an IRA. (The lender needs to see withdrawals for at least two months). This $4,500 would be considered monthly income. Sometimes, the lender will need a letter from a financial planner or financial institution confirming these withdrawal amounts.
For retirees with a lot of invested assets, the asset-depletion method of determining income may work well. With this method, the lender starts with the current value of financial assets. Then they subtract any amount that will be used for the down payment and closing costs. They take 70% of the remainder and divide by 360 months.
For example, suppose someone has $1 million in financial assets. They are going to use $50,000 for a down payment. That leaves $950,000. Take 70% of that, which is $665,000, and divide by 360. The result, $1,847, is the monthly income used to qualify the borrower.
Of course, any other sources of income, such as pension income, Social Security, or monthly annuity income, would also be counted in addition to income using the methods above.
Debt-to-Income and Housing-Expense Ratios
Once income is determined, your total debt-to-income ratio and housing-expense ratios must meet the lender’s requirements.
For a qualified mortgage (QM) that falls within the safe harbor regulatory requirements, no more than 43% of your income can go toward debt servicing. This ratio of debt payments to income is called the "debt-to-income ratio."
Debt includes required payments like alimony and child support as well car payments, student loan payments, credit card minimum payments, and your total projected house payment, including principal, interest, property taxes, and insurance.
One thing that can get retirees in trouble in this area is co-signing on loans for adult children. Even though you are a co-signer, those payments can count as required debt payments and may reduce your ability to qualify for a mortgage.
Your housing expense includes the principal and interest portion of the mortgage as well as taxes and insurance (referred to as PITI). This ratio must be under 28%, meaning that your housing expense cannot exceed 28% of your income. PITI plus other debt obligations (e.g., credit card or child support) should be no more than 36%.
Use our mortgage calculator to estimate your monthly housing payment, including principal, interest, property taxes, and homeowners insurance (plus private mortgage insurance, PMI, if your down payment is less than 20%).
Credit Score Requirements
Each lender will have its own credit score guidelines, but one thing is for sure: the lower your credit score, the higher your interest rate. If you want the best rates, get your credit score to 780 or better. A better credit score can also give you more wiggle room in other qualifying areas.
Another factor that is used to determine your interest rate on a mortgage is your intended occupancy. Will this be a primary or second home? Primary homes get better rates.
As a retiree, your required down payment can vary, depending on the income method used. For the drawdown-in-retirement method, you can put as little as 5% down. For the asset-depletion method, plan on putting 30% down.
If you’re thinking of coming up with your down payment by taking a big chunk of cash out of an IRA or another tax-deferred retirement plan, be aware that the withdrawal will all be taxable income and that taking a big chunk out in a single year may bump you into a higher tax bracket.
Another requirement will be the amount of post-closing liquid assets that you have available. Lenders want to see that you will have at least six months of total housing expense (PITI) as a minimum remaining reserve after you've bought the home. To calculate this, the lender will add up all financial assets that can be verified (meaning that you need account statements) and then use 60% to 70% of that amount.
Other Lending Options
If you qualify as a veteran, you may want to look into a VA Loan. With a VA loan, you can put zero down, but instead of a down payment you will pay a funding fee, which can be 2.30% of the loan amount for first-time users of the program, and 3.60% if you have taken a VA loan in the past. This funding fee can be financed into the loan.
VA loans require a debt-to-income ratio of 41% or less, and they require you to have some residual monthly income. Residual income can be determined by taking a two-year average of your dividend and interest income from Schedule B on your tax return.
Applying for a Mortgage
The best way to find out what kind of mortgage you can qualify for is to talk to a mortgage broker. Guaranteed Rate offers loans in all states and even has an online program called Digital Mortgage, where you can go through the entire process online.
You also will want to do your due diligence on the house you are buying. For that, check out HouseFax. It’s like a CarFax® but for your house.
Should You Have a Mortgage in Retirement?
What is the best mortgage for a retiree? Probably none. Research shows that most retirees are better off paying off their mortgage before retirement. One notable exception, however, would be higher-net-worth individuals, who may be able to use debt to their advantage, even throughout retirement.