The “Asset-Rich, Income-Poor” Dilemma
Retirees face many important decisions when they retire, one of the biggest being where to live. Oftentimes, retirees want to move somewhere warmer, closer to family, or senior-friendly. After putting in the time and effort to find a “forever home,” many retirees are left scratching their heads when they find out they can’t qualify for a mortgage in retirement. Why do retirees, even those with millions in assets, struggle to qualify for a mortgage?
The unfortunate answer is that many lenders prioritize income over wealth when doling out mortgages. You can have millions sitting in your retirement accounts, but if you’re not taking home a large enough monthly paycheck, you may not get very far. More and more retirees will face this reality, as the popularity of pension plans has declined over the past several years, making Social Security the only “income” retirees can use to qualify for a mortgage.
While this antiquated view of income can seem to limit many retirees from purchasing a home, there are strategies that can help you “prove” you have income and qualify for the mortgage option you want.
Why Do Retirees Struggle to Get Mortgages?
1. Traditional Lending Models Don’t Account for Retiree Wealth
Most lenders haven’t updated their qualification criteria to account for the current reality of retirement finances. Lenders expect steady W-2 income to approve loans, which isn’t feasible for most Gen X and younger retirees relying on savings in accounts like a 401(k) or IRA instead of traditional income sources. They can have $5 million in retirement savings and no debt, but they will still be unable to get a mortgage if they don’t have a large enough pension or Social Security.
However, this doesn’t mean there are no ways to “prove” income. In fact, those same retirement savings that didn’t qualify can be used to help. The trick is structuring your investment withdrawals to act like “income,” even without receiving a W-2, so that they can be used to help you qualify.
2. The IRA Withdrawal Trap: Unnecessary Tax Bills Just to Satisfy Lenders
Frequently, retirees are forced to take distributions from their retirement accounts, typically IRAs, to create “documented income.” On the surface, this may not seem like too arduous a hoop to jump through, but we have to keep in mind that IRA withdrawals are taxable at ordinary income rates.
Creating enough “documented income” to qualify for a mortgage can be done in a few different ways, but the most common way is to take a large enough regular (e.g., weekly) withdrawal from an IRA to qualify. Usually, the lender will inform retirees how much income is required to qualify for the home loan, and the withdrawal plan can then be established according to the lender’s parameters.
Some retirees may be taking withdrawals anyway, as retirement savings are meant to be used in retirement, but others may not be. There are many scenarios where retirees are not withdrawing from retirement accounts to achieve tax or other financial planning objectives.
For example: A single retiree has $4 million in an IRA with no existing mortgages or other debts. They earn no Social Security or pension income but didn’t plan to withdraw from their IRA this year because they have more than enough cash to fulfill their goals. To purchase their new home, they will need to withdraw $100,000 from their IRA to “prove” they have income. Now, when they file their tax returns, a year that was supposed to have minimal taxes instead generates a $20,000-plus bill just to satisfy the lender!
3. Debt-to-Income Ratio (DTI) Rules Are Rigged Against Retirees
Proving income is usually the main hoop retirees must jump through, but other aspects of underwriting also work against them. Not everyone retires debt-free, nor is it always advised since hanging on to “good” debt can sometimes be a benefit. However, debt can work against retirees during the mortgage lending process. While they may be in an extremely strong financial position with debt, underwriting will require even more income for those who have it.
This part of their calculation is called the debt-to-income ratio (DTI). The formula looks at income compared to monthly debt payments, and most lenders usually require debt to be below 43-45% to qualify for a mortgage. For example: If a retiree earns $1,000 per month and pays $430 per month toward debts, then their DTI is 43%.
You may have already noticed what isn’t included in this calculation: net worth. The entirety of retirement savings is completely ignored, even though there could easily be enough saved up to pay off any debts and leave money left over.
For example:
Retiree A has a $2 million IRA, earns $30,000 per year in Social Security, and pays $10,000 per year toward a car loan, with $20,000 remaining. They are denied due to “low income.”
Working Applicant B has no savings, earns $75,000 per year in W-2 income, and pays $7,000 per year toward student loans, with $100,000 remaining. They are approved.
When you read those examples, who seems more qualified to you? Who would you trust to make mortgage payments month in and month out? If I were providing someone with a loan, I would rather give it to the person with enough assets to pay it off, not the person who relies upon at-will employment without a safety net. Yet Working Applicant B could be approved and receive a more favorable interest rate than Retiree A.
While it isn’t a part of DTI, keep in mind that credit score will always be an important factor in qualifying for a mortgage. You’ll want to check your credit report before you apply for a mortgage, and you can do so via one of the three main credit bureaus (Equifax, Experian, and TransUnion). Most loans require a credit score of at least 620 to qualify.
Choose a Lender That Understands Retiree Finances
As discussed, most lenders do not underwrite in a way that is appropriate for retirees. The requirements for income force retirees to make unadvantageous financial decisions that can derail financial planning strategies, ultimately putting retirees in a worse financial position to prove they are in a good enough financial position to repay the loan. It’s a paradoxical system.
Some lenders recognize the issues in the established underwriting system and instead specialize in asset-based underwriting. This means they evaluate total wealth, not just monthly income, and retirees can avoid having to take withdrawals and recognize unnecessary tax bills just to qualify. Lenders who provide portfolio-based loans or verify income in an alternative way can be a lot more beneficial than traditional lenders for newer retirees.
The way underwriting is done will likely be a slow change without regulations that provide more equity for retirees in the process. Acts passed in the past, like the Equal Credit Opportunity Act, address discrimination in denying credit on the basis of social factors. Similarly, regulations may need to be put in place to help protect retirees from financial discrimination.
It is common for retirees to move in retirement, which often means taking a mortgage. Most lenders underwrite based on income, which works against retirees due to the decline in popularity of pension plans and, therefore, retiree income. Retirees are forced to jump through hoops and take unfavorable, taxable distributions from retirement accounts just to fit the mold of the underwriting system.
While some lenders specialize in asset-based underwriting, they are not as commonplace as traditional mortgage lenders, and there may be no other option for a retired homebuyer but to take a taxable withdrawal. Until the underwriting system adjusts for the new reality of retirees, careful tax planning is necessary to ensure a “forever home” purchase doesn’t cause more problems than it’s worth.
Discuss your situation with a fee-only financial advisor.
Divergent Planning, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Divergent Planning, LLC or performance returns of any Divergent Planning, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Divergent Planning, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Divergent Planning, LLC provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. Divergent Planning, LLC is not responsible for errors or omissions in the material on third party websites, and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.
Divergent Planning, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Divergent Planning, LLC and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Divergent Planning, LLC unless a client service agreement is in place.