How to Buy a Home in Retirement
Why it has become easier for retirees to qualify for mortgages
(This article previously appeared on HSH.com.)
Mortgage lenders qualify borrowers for a mortgage based on their credit and income, which used to make it difficult for retired borrowers due to their lack of income. However, Freddie Mac recently introduced a rule to allow retirement assets to be used to qualify for a mortgage loan.
"Lenders can look at your IRA and 401(k) and lump-sum retirement account distributions as income, but there are some restrictions," says Brad German, a spokesman for Freddie Mac in McLean, Va. "In order for the money to be counted, you can't be using these assets for current income, not even the dividends or interest from the investments."
You also must be fully vested with complete access to the funds without incurring a penalty for early withdrawal.
"Before this rule was changed, lenders couldn't use any retirement assets to qualify someone for a mortgage," says Brian Koss, executive vice president at Mortgage Network. in Danvers, Mass.
Fannie Mae has a similar rule regarding retirement assets, says German.
How the Fannie Mae Rule Works
German says a formula limits lenders to include 70 percent of the assets and then subtract the funds needed for closing costs and down payment and then divide the remaining money by 360 months, regardless of the actual loan term.
For example, Koss says, someone with $1 million in retirement assets would be allowed to include $700,000 of those assets minus approximately $10,000 for closing costs and then given a credit of $1917 per month as income.
Places Where Your Income Goes Farthest
Recognizing that people are still hurting from the recession and are concerned about whether their retirement savings will last, AARP's researchers identified 10 locations where housing costs are lower than average, says Gabrielle Redford, editorial projects manager for AARP magazine in Washington, D.C.
"We worked with a demographer to estimate the budget for a typical retired couple with Social Security and some other assets and determined that if they spent about one-third of their income on housing costs they could buy a $125,000 home with a mortgage payment of about $500 per month," says Redford. "Then we looked at property taxes, sales tax and cost of living expenses. We also checked crime rates and the availability and cost of health care."
After the researchers identified affordable areas, they evaluated livability.
"We wanted to know what there is to do in various places including art and culture," says Redford. "There's no point in moving someplace because it's less expensive if there's nothing to do but sit there."
AARP's Top 10 list of low-cost places to retire includes:
1. Daytona/Deltona/Ormond Beach, Fla,
2. Pocatello, Idaho
3. Bangor, Maine
4. Greenville, S.C.
5. Grand Rapids, Mich.
6. South Bend, Ind.
7. Erie, Pa.
8. Louisville, Ky.
9. Sherman/Denison, Texas
10. Pueblo, Colo.
Retirees and Mortgage Loans
If the idea of moving to a low-cost area after retirement is appealing, Koss suggests selling your current home first to generate liquid cash.
"Retirees should consult with an investment adviser and tax expert as well as a lender to decide how much of your cash to spend and how much of your purchase to finance," says Koss. "Some people emotionally don't want to have a mortgage in retirement, but if you need to stretch your assets and need the tax deduction it may make more sense to put down 30 or 50 percent and finance the rest."
Koss says lenders often require a two-year history of draws on assets to see that retirees have the discipline to manage their money. However, the Freddie Mac rules won't allow you to use the assets you're currently using as future income for the purposes of a loan approval. If possible, Koss suggests planning ahead by using one account for expenses and leaving others untouched before a loan application.
"Meet with a lender for a preapproval for a loan so that you can find out if your credit score is acceptable and to discuss your loan options," says Koss. "In many cases a 30-year loan works well for retirees because the payments are smaller."
Those small payments can go far if you opt to buy in a low-cost area, too.
"We were surprised to find such great places," says Redford. "We expected to find nothing much, but this isn't even an exhaustive list. You can find lots of places that fit your interests where you can live for less."