If you're at or near retirement and looking for a new mortgage, it might call for more preparation than any previous home purchases.
While many in their 60s and 70s are still working full time and may be able to handle a mortgage more easily than someone who is retired, it's still a good idea to consider how you'll manage mortgage payments when you retire and potentially have less income.
The home purchase process for seniors
To lenders, age isn't a factor – a 67-year-old has as much chance of buying a home as a 37-year-old. In fact, the Equal Credit Opportunity Act prohibits lenders from discouraging consumers from taking out a mortgage based on age.
The most important criteria are the same – income, assets, credit report, credit score – and the paperwork you submit to the lender will reflect that.
"There's nothing that's different for a borrower that's 65 or over versus a borrower in their 30s – it's all about their ability to repay," says Ron Haynie, senior vice president of mortgage finance policy at the Independent Community Bankers of America. "Financial institutions will make their underwriting decisions based on the facts in front of them."
That puts the onus on the applicant to know whether the mortgage payments will be sustainable based on future income while also factoring in unexpected but common hurdles, such as medical issues and bills.
"People who take out a mortgage loan at 64 years old while making $150,000 year and choose to retire next year and make half or 40% of that need to think about that when they're doing their financial planning," Haynie says. "There is a responsibility on the part of the borrower as to what they're getting into financially at this stage of their life."
Mortgage approval in retirement
When you're retired, instead of submitting W-2s to show income, you're more likely to indicate what kind of ongoing income you're getting from a pension, Social Security, and 401(k) and IRA accounts.
Lender guidelines from Freddie Mac – a government-controlled enterprise that buys loans from financial institutions to free up more lending capital – allow borrowers to use lump-sum retirement account distributions from 401(k)s and IRAs to help determine mortgage eligibility. Lenders also can consider interest payments, Social Security income, trust funds, dividend income and even money earned from the sale of a business.
But when you rely on continual income from assets that have a defined expiration date, such as IRAs, 401(k)s or trust disbursements, lenders will probe whether these funds will continue for a three-year period.
As noted in guidance from Fannie Mae, another government-controlled enterprise that purchases mortgages from lending institutions: "Lenders must consider the borrower's continued capacity to repay the mortgage loan when the income source expires or the distributions will deplete the asset prior to maturation of the mortgage loan."
If you're relying on assets to help you qualify for a loan, realize lenders can only consider 70% of the value of accounts made up of bonds, stocks or mutual funds because of their volatility. It's also important to have penalty-free access to accounts, which means your age will be considered if you have an account with early withdrawal penalties.
What seniors should consider before taking out a mortgage
Ongoing costs in retirement ought to be top of mind for potential mortgage purchasers who are at or near retirement age, especially as people continue to live longer.
About 24% more Americans 60 and older held mortgage debt in 2015 than in 1980, according to a 2018 research paper by the Center for Retirement Research at Boston College.
The goal should be to live within your means, to make sure you don't run out of funds and wind up in bad shape in your retiring years, says John J. Vento, a certified public accountant, certified financial planner and author of "Financial Independence (Getting to Point X): A Comprehensive Tax-Smart Wealth Management Guide."
"You don't want to be 75 years old, with a big mortgage on your home, and are not sure where you're going to get the money to pay the mortgage each month," Vento says.
For example, according to Fidelity Investments' 16th annual retiree health care cost estimate, a 65-year-old couple retiring in 2018 would need $280,000 to cover health care expenses during retirement, a 75% increase from the 2002 estimate of $160,000.
Mortgage debt is an expected expense, "but typically a very large expense, which can lead to seniors taking on other debt, such as credit card debt to maintain a standard of living with a reduced income in retirement," says Craig Copeland, senior research associate at the Employee Benefit Research Institute. Copeland is the author of a recent report that found the proportion of indebted families headed by someone at least 75 years old increased from 31.2% in 2007 to 49.8% in 2016.
"If this expense was paid off, seniors' budgets would be in a much better shape to spend on other items with accruing other debt," Copeland says. "It is debt that can lead to more debt, which will result in a very difficult financial situation in retirement."
Tax benefits are traditionally an important reason for seniors to own a home. But the recent tax reform bill made a few notable changes that hit during the 2019 tax season:
- The increase in the standard deduction made it less likely that taxpayers would itemize their income taxes.
- Deductions for property taxes are limited to $10,000, which limits deductions for many residents in higher-tax states.
- Interest on up to $750,000 of mortgage debt can be deducted by new homebuyers if they are married and file jointly. The level decreases to $375,000 if filing individually. The previous levels were up to $1 million if filing jointly or $500,000 if filing separately.
- Interest on a home equity loan or line of credit is tax-deductible only if the debt came from a home improvement project.
During the 2019 tax season, many of Vento's clients who used to itemize didn't do it on their 2018 taxes. "They really got no benefit from that mortgage," Vento says.
Mortgage refinancing and home equity loans for seniors
Steady income can be a challenge for some senior citizens, which could make accessing equity with a mortgage refinance or home equity line or loan a tempting option.
A traditional refinance would allow a homeowner to get a more advantageous interest rate and also possibly adjust the term of a loan.
A cash-out refinance allows homeowners with equity in a home to get a new, larger mortgage and get the cash difference between the new mortgage and current mortgage. But you would have to qualify for a larger mortgage and also deal with a new 15- to 30-year mortgage payment, which basically means you're taking out hard-earned equity and paying it back.
Homebuyers "should really evaluate how long they intend to stay in that property as there will be costs and fees associated with the refinance," Haynie says. "Also, if they are within 10 years of paying their home off, they may be better off staying with their current mortgage." In the final years of a traditional fixed-rate loan, most of the payment goes directly toward the principal.
A home equity loan or line could allow seniors to use the equity in their home to get immediate cash, especially if they have plenty of equity already. But only 20% of people 65 and over surveyed by the National Council on Aging said they were willing to draw on equity, although the 2017 study also indicated confusion and lack of awareness about home-equity-focused options.
Homeowners must make monthly payments with a home equity line or loan, and both options make a home subject to foreclosure if payments are not made. There are also fees and closing costs when the loan is set.
What seniors should know about reverse mortgages
If you're 62 or older and own a home, another way to tap home equity is to apply for a reverse mortgage. Unlike a common home equity loan, a reverse mortgage won't require repayment right away. That would happen once you move out or pass away.
There are a few types of reverse mortgages, but the most common is the Home Equity Conversion Mortgage, which is backed by the Federal Housing Administration and allows you to spend the money in any way you'd like.
Some of the requirements to qualify for an HECM:
- The house must be considered your primary residence.
- You must be able to pay for taxes, insurance and upkeep of the home.
- You must meet with a housing counseling agency.
A reverse mortgage can be a lifesaver for some seniors, says Haynie. His parents benefited from a reverse mortgage arrangement that helped them pay medical bills and other daily expenses.
"It immediately frees up cash flow," Haynie says. As long as you can pay taxes and insurance, it can be a boon to people on a fixed income who need extra money.
Two keys to getting a reverse mortgage, Haynie says, include:
- Having enough equity in your home. At least 50% is best, Haynie says.
- Long-term planning. You don't want to run up the balance on a reverse mortgage and get caught with a balance that exceeds the property value, if that value plunges, Haynie says. Thankfully, most reverse mortgages are insured by the Federal Housing Administration, which means if you or your family sells the home to pay off the loan, you won't have to pay the difference – if there is one – between the sale price and the mortgage, as long as the sale is for at least 95% of the current appraised value.
While a reverse mortgage can provide cash up front, it can also cause you to lose all the equity in your home, which decreases the assets you have and could leave behind to your family.
Vento is concerned that some seniors who are sold on reverse mortgages are persuaded to stay in a home they can't really afford. As every month goes by, they owe more in the property and have a "false sense of security," Vento says. He suggests it's often better to sell a home instead.
Other concerns about reverse mortgages:
- There are fees associated with arranging and closing the loan.
- The amount you owe will grow as interest adds up.
- Interest is not tax-deductible, and rates could go up.
- You're still responsible for home costs such as insurance, property taxes and upkeep.
"When you're a senior, you shouldn't be overleveraging yourself," Vento says. "You shouldn't do it when you're young, in my opinion, but for sure not when you're 60 or over."
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