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How to Qualify for a Mortgage When You’re Retired

June 20, 2024

Qualifying for a mortgage in retirement may seem challenging, but it’s entirely possible with the right approach. When a person retires, they usually have considerable assets but not necessarily a lot of income, so we are going to explain the different ways we can compute income for these individuals.

For most people, the longer you can hold your assets without liquidating them to put down money for a mortgage, the better. There are ways to use those assets to qualify for a mortgage without liquidating them. Pulling excessive amounts from qualified accounts may wind up creating a taxable event that nobody wants.

We will start by explaining why mortgage companies must compute income for homebuyers. Then, we will cover asset depletion methods, distribution from qualified accounts, and income from dividends and interest.

Why Does a Mortgage Company Have to Compute Income?

After the mortgage crisis of 2008, several laws were passed. One of which was Dodd-Frank, which introduced increased requirements for mortgage lenders. The “Ability to Repay” or ATR requires each mortgage originator to document a borrower’s income, debts, assets, and credit history in order to support a conclusion that the home borrower has the ability to repay the mortgage for which the borrower was applying. Income for a retired person also differs from most working individuals’ standard check stub and W2.

Debt-to-income (DTI) ratio significantly influences mortgage eligibility, as it measures the percentage of a borrower’s gross monthly income that goes toward paying debts. Lenders use this ratio to assess an applicant’s ability to manage monthly payments and repay borrowed money. A lower DTI ratio indicates a healthier balance between debt and income, increasing the likelihood of mortgage approval and potentially securing more favorable loan terms. Conversely, a higher DTI ratio suggests greater financial strain, which can result in higher interest rates or even loan denial, as it signals a higher risk of default.

debt to income ratio

Asset Depletion

Instead of relying primarily on traditional income verification, lenders calculate a borrower’s ability to repay the loan by depleting their liquid assets over a set period, typically the term of the loan. This method converts the value of assets like savings accounts, investments, and retirement funds into a monthly income equivalent.

This approach involves calculating a hypothetical monthly income based on your total assets.

Here’s how it works:

  • Lenders will consider a percentage of your liquid assets, like savings, investments, and retirement funds.
  • They divide the total by a set period, often the loan term, to estimate a monthly income.
  • If the assets are also the source of the down payment, the assets will be reduced by the down payment amount.

Asset depletion mortgages are particularly beneficial for retirees, self-employed individuals, or those with substantial investments. This technique will often supplement a main income such as Social Security Income (SSI) or a pension.

Distribution from Qualified Account

Assuming that the homebuyer is of retirement age, 62 and older, we can derive income by moving assets from a qualified account like an IRA or 401k to a checking account. Again, this is not income in the IRS sense but income for a mortgage company to analyze the ability to repay (ATR).

There are a few keys here. A short history of distributions is required, but the assets must be sufficient to support a 3-year continuance at the documented distribution amount. So, in other words, if the mortgage applicant is taking out $1,000/month from an IRA, the balance must be at least $36,000 ($1000 x 12 months x 3 years). After closing on the mortgage, the borrower can stop receiving payments from the IRA if there is no need for the distribution.

This technique is very advantageous because it keeps buyers of retirement age from liquidating large amounts of assets which could trigger taxes but allows people to buy a home.

For example – John and Mary are applying for a mortgage. They are both 62, collecting pensions, but won’t collect social security until 65. They are buying a home but don’t have enough documentable income. They can move assets from a 401k to their checking account for two months prior to application to qualify for the mortgage. Once they close, they can stop the distribution if they do not need the extra income.

Dividends and Interest

This is often overlooked as a source of income. However, those with a great deal of assets, just not income, can use these to qualify for a mortgage. The income can be used as long as there is a history of receiving this type of income on a historical tax return and the borrower owns the underlying asset at the time of closing.

For example, a borrower owns $1,000,000 of S&P 500 stock, which pays a dividend of 4.5%. The mortgage company can use $3,750 per month as income on the mortgage application.

Tips to Qualify

Maintain a Low Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is a key factor in mortgage approval. It measures the percentage of your monthly income that goes toward debt payments. To improve your DTI ratio:

  • Pay Down Existing Debts: Reduce credit card balances, personal loans, and other outstanding debts.
  • Avoid New Debts: Hold off on large purchases or new loans before applying for a mortgage.

A lower DTI ratio not only improves your chances of approval but can also lead to better loan terms.

Consider a Larger Down Payment

Putting down a larger down payment can make you a more attractive borrower. It reduces the lender’s risk and can compensate for lower income or higher DTI ratios. A substantial down payment can also lower your monthly payments and potentially eliminate the need for private mortgage insurance (PMI).

Boost Your Credit Score

A higher credit score can improve your mortgage terms and approval odds. There is a difference between a good and a great credit score. To boost your score:

  • Pay Bills on Time: Ensure all your bills are paid promptly.
  • Reduce Credit Card Balances: Aim to keep your credit utilization low.
  • Check Your Credit Report: Look for errors and dispute inaccuracies.

Consult a Mortgage Professional

Working with a good, trusted lender like Homestead Financial Mortgage can help you navigate the complexities of qualifying for a mortgage in retirement. They can offer tailored advice, present suitable mortgage options, and assist with the application process.

Qualifying for a mortgage in retirement is attainable with the right strategies. You can improve your chances of securing a mortgage by demonstrating sufficient income, leveraging assets, maintaining a low DTI ratio, and ensuring you keep your credit score up. Remember to consult professionals who can guide you through the process and help you find the best mortgage solution for your retirement years. With careful planning and preparation, homeownership or a refinance can be another stress-free part of your retirement journey.

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