Why baby boomers should secure a mortgage before retirement

By Amy Fontinelle
Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Posted on Jan 29, 2018

Baby boomers who are thinking about changing their primary residence after they retire and who will need a mortgage to do so may benefit from making the move while they are still working.

That will not always be possible, of course. If, for example, retirement plans include selling the house in New Hampshire and moving to Florida … but work remains in New Hampshire … there is no moving early unless an employer allows for working remotely. 

But near-retirees who do not plan to move far from their current residence — perhaps because the main reason for moving is to get a smaller or larger home, a more accessible home, or a home with fewer maintenance requirements — should consider getting the loan for that home while they are still working. Qualifying for the mortgage will likely be easier and they may be able to borrow more.

(Related: Retirement calculator)

The importance of income

Lenders cannot discriminate against borrowers based on age, and they do not care, per se, whether an applicant is working or retired. What they care about is …

  • Whether an applicant has the income to repay what they are asking to borrow.
  • Whether existing debt could interfere with making the proposed loan payments.
  • Whether the applicant’s credit history shows that they are a responsible borrower.

(Lenders often resell mortgages to Freddie Mac and Fannie Mae, government sponsored enterprises that buy mortgages from lenders, provided those mortgages meet their standards. Both require borrowers to have a minimum credit score of 620.)

After retiring, borrowers cannot simply provide copies of W-2s, the tax forms that show annual employment earnings, to prove that they have the cash flow to repay the loan. Instead, they have to show that Social Security, pension, and retirement account income and assets will be sufficient to repay the loan.

Qualifying with Social Security and pension income is simple enough, but qualifying with retirement account income and assets from accounts like 401(k)s and IRAs can get tricky. Retirees need to be taking regular withdrawals from these accounts that are high enough to support their proposed housing payment, or they need to have enough untouched assets in these accounts to qualify under asset depletion calculations.

Applying while working can mean a larger loan

Different lenders use different formulas to turn a retiree’s untapped assets into qualifying income for a mortgage. Here is an example of how they might do it and how someone might be able to borrow more by taking out a home loan while they are still employed.

Suppose that while working, Helen draws a pre-tax salary of $100,000 per year, which translates to $8,333 in monthly income to qualify for a mortgage. If she wants to borrow $300,000 at an interest rate of 5 percent, lenders will not care about her retirement account balances because she has enough current income to repay the loan she is applying for.

Yes, Helen’s is very much a best-case scenario, but it simplifies things for our example. Realistically, many retirees will have more than the mortgage payment on the debt side of the equation and taxes to consider. According to the Pew Survey of American Family Finances, retirees commonly carry credit card, automobile loan and student loan debt. And at age 65, retirees can expect to spend an average of $583 per month on premiums for Medicare Part B, Part D, and a supplemental policy, according to the 2015 Retirement Health Care Costs Data Report from HealthView Services. That figure does not include out-of-pocket expenses.

Now, suppose Helen has stopped working and is drawing $2,000 a month in Social Security income but is not touching her retirement accounts because she does not need the money yet. She is living in a paid-off house, does not have other debt, and her medical expenses are low.

Helen has $1 million in a 401(k). Here is how lenders might turn that account balance into qualifying income following guidelines from Freddie Mac, which, like Fannie Mae, provides much of the money that lenders use to issue mortgages.

First, the lender will discount that $1 million to $700,000 because only 70 percent of retirement assets can be used to qualify. This rule exists since investment assets fluctuate in value and might experience a significant loss that would lower the account’s value.

Next, the lender must divide that $700,000 by 360, the number of months in a 30-year loan. That is the rule even if the borrower is taking out a 15-year loan that will only last 180 months. (One could also argue that it is overly optimistic to assume Helen, age 65, needs her assets to last until age 95.)

The result is $1,944 in monthly income to qualify Helen for a mortgage — far less than the $8,333 in pre-retirement qualifying income.

Lenders do not require borrowers to actually start taking these withdrawals as a condition of getting the loan; they just use this calculation to qualify borrowers.

Financial planner Paul Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois, said he has found that some lenders’ formulas are more liberal. Instead of the roughly $23,000 in annual income that results from the above formula, the lender might assume a reasonable withdrawal rate of 4 percent to 5 percent of the retirement account balance annually, resulting in $40,000 to $50,000 in annual qualifying income, or $3,333 to $4,166 in monthly qualifying income.

Lenders that use different formulas are portfolio lenders, meaning they do not resell the mortgages they issue to Fannie and Freddie. 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, further explained that some lenders will assume the assets will continue to earn interest while they are being depleted, whereas Freddie’s formula assumes they earn nothing.

If retirement account assets are invested, not sitting in cash, then Freddie’s formula may be overly conservative. (Related: Is It OK to Retire with a Mortgage?)

Qualifying based on retirement account income

What if Helen were already drawing on her retirement accounts when she applied for a mortgage? Would she still qualify for a smaller loan than she would have while she was working?

The answer is probably yes.

Ruedi and Fleming said lenders generally require two years of withdrawals of enough income to support the proposed mortgage payment, though some will accept a shorter period, depending on whether they are reselling the loan and to whom.

Ruedi said that borrowers who have just retired and just started taking withdrawals may be able to get approved by providing a letter from the retirement account custodian or a bona fide financial advisor stating that the account has enough assets to cover three years of withdrawals at the current qualifying withdrawal rate.

Fleming explained that if a borrower had already been taking withdrawals for the requisite number of years but those withdrawals were not high enough to support the mortgage in question, the borrower would have to make a strong case showing the lender that increasing the withdrawal rate would not deplete the assets before the loan is paid off.

“No lender wants to show up on the news foreclosing on Grandma,” Fleming said.

Borrowers should carefully consider, however, whether it makes sense to borrow based on their pre-retirement income if they expect their postretirement income to be lower. Why add financial stress to the other challenges of retirement by taking on too much debt? The goal is not to borrow as much as possible, but to enjoy a comfortable retirement.

The bottom line

Since almost everyone brings in less income during retirement, it is usually easier to qualify before retirement. “I recommend that folks thinking about retirement investigate their options, and choose the mortgage plan that works best for them before they do so, and before they announce to their employer that they are retiring,” Fleming said.

With a lender’s or financial advisor’s help, near-retiree borrowers should to do the math using their own working income and projected retirement assets and income to see whether qualifying after retirement will be unnecessarily difficult.

“Sometimes it doesn’t matter — if, for instance, you qualify just fine with your retirement income, then you don’t need to worry about it,” Fleming said.

In any case, planning ahead can help keep retirement plans on track.

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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.