Retirees trying to buy a home can run into a Catch-22 at the bank.
They don't work, so they don't have income from a job. Instead, most of their money is in a retirement account, which isn't counted as income. As far as a bank is concerned, they don't have enough income to qualify for a mortgage, even if they have a large retirement account.
They're asset rich but retirement poor in income.
Little-known and no-so-recent changes by two of the biggest backers of mortgages - Freddie Mac and Fannie Mae - allow retirement assets to be used to qualify for a mortgage loan. The relatively new rules will help retiring Baby Boomers, for example, who have limited incomes but substantial financial assets, to qualify for a conforming, conventional mortgage.
Banks not always aware of this option
The guidelines took effect in spring 2011, but the news hasn't spread too far and many borrowers aren't aware of them, says Brad German, a spokesman for Freddie Mac.
Some banks aren't aware of them, or at least don't have experts who can discuss the rules. Representatives for Bank of America and Bank of the West declined to be interviewed for this story, saying they didn't have many customers affected by these loans, or they didn't have someone available who was knowledgeable enough to talk about them.
They surprised Jeff Currie, a financial adviser for Currie Financial Group in Boise, Idaho, who helps retirees move retirement distributions to a single premium immediate annuity, or SPIA, so the investment can be listed as retirement income for lending purposes. SPIAs are no longer needed under the new rules, Currie says.
"I think this is a great change for the consumer," he says.
How it works
Here's how the Freddie Mac guidelines work, according to German:
- IRA and 401(k) accounts, lump-sum retirement account distributions, and the proceeds from the sale of a borrower's business can be used to determine a borrower's eligibility.
- Assets in an IRA or 401(k) must be in a full-vested retirement account recognized by the IRS.
- The assets must be entirely accessible to the borrower, not subject to a withdrawal penalty, and not be currently used as a source of income. Not even the dividends or interest from the investments can be used as income.
- To determine borrower eligibility, the lender first adds up the eligible assets, multiplies the total by 70%, and then subtracts the funds needed to complete the transaction, such as down payments, closing and financing costs, and escrow.
- The remaining amount is divided by 360 months, regardless of the loan term.
For example, someone with $1 million in retirement assets could include $700,000 of those assets, minus approximately $10,000 for closing costs. They'd be left with $1,917 per month as income.
It's a long step from before the rule change, when lenders couldn't use any retirement assets to help qualify a retiree for a mortgage.
German points out, however, that Freddie Mac "has long allowed lenders to use income from dividends, interest payments, trust distributions, and Social Security payments in calculating a borrower's qualifying income."
Long-term mortgage can free up cash
Because the retirement assets can't be currently used as a source of income to qualify for a mortgage, it's important to use one account for expenses and leave others alone before applying for a loan.
Having a 30-year loan at age 65 or so can be emotionally daunting, but it's a way to have more cash available for living expenses because the mortgage payments on a longer loan will be less than they would for a shorter loan, Currie says.
"It doesn't make sense to pay it off in time" for people in their 60s with a mortgage of $100,000 or more who are in a fixed income and won't be able to pay off the mortgage in the lifetime anyway, he says. It will leave them house rich but cash poor.
For retirees and near-retirees thinking of selling their homes and moving somewhere else for retirement, these recent rule changes can be a way to qualify for a mortgage without moving money out of their retirement accounts. They'll remain cash rich, too.