Once they’re retired, many older adults find they want to downsize or move to a new city. Many older adults find they want to downsize or move to a new city when they retire. This can be an exciting and challenging time to get a mortgage
While lenders are prohibited from discriminating against loan applicants based on age, retirees still face greater challenges than working adults when it comes to securing a mortgage.
Here, The Motley Fool discusses a few things you should know about getting a mortgage in retirement before you start filling out those loan applications.
Buying a new home in retirement isn’t always wise
Even if you do get approved for a mortgage, it’s a large expense. Most retirees have lower incomes than they did while they were working and underestimate how long their money will need to last. Adding a mortgage payment to your monthly expenses could deplete your funds even faster, leaving you struggling to make ends meet. Evaluate your finances carefully before applying for a mortgage to ensure that you have plenty of money saved to comfortably sustain you for the rest of your life. Note: it’s a good idea to overestimate, just to be safe.
Evaluate how much debt you have
If you fall behind on your payments, the debt could hurt your credit score and also raise your debt-to-income ratio. Both of these things can make it more difficult to secure a mortgage. Plus, debt places additional demands on your budget. If your debt spirals out of control, you may have trouble paying your monthly mortgage payments. For many retirees, it’s wiser to stay in their existing home—especially if it’s paid off—or consider renting a smaller place, rather than to take on a new mortgage. However, if you have a solid nest egg and little to no debt, then you may not have any trouble paying for a new home, especially if you use the proceeds from your existing home’s sale to make a large down payment on a less-expensive house.
Showing enough income is the biggest challenge
Retirees are no longer working, so they cannot show traditional income from a job. But you don’t need a job to get approved for a mortgage: Any income you’re receiving from pensions or Social Security will count, and if you’re taking regular withdrawals from your retirement accounts, these often count as well. If you’re not taking money from your retirement account, the lender may be willing to assess your “income” through a method called asset depletion. This includes the value of all of your financial assets, minus the cost of the down payment. Then 70 percent of the result is divided by the number of months in the loan term to come up with your theoretical monthly income. Apart from showing a steady income, you also have to have a low enough debt-to-income ratio. This may or may not be a challenge, depending on how much debt you have and how much income you have in retirement. Most lenders require you to keep your debt-to-income ratio at 40 percent or less, meaning that your debts take up no more than 40 percent of your monthly earnings. Any more than that may indicate that you’re living beyond your means and may be unable to pay back what you owe. Talk to your lender about your income and debt-to-income requirements before you fill out a mortgage application to get a sense of what you should be aiming for and to make any necessary adjustments, such as paying down debt or taking a little more money from your retirement accounts each month.
Other factors lenders consider:
Credit score – Income is important when you’re applying for a mortgage, but it’s not the only factor that lenders consider. Your credit score also plays a major role, because it provides financial institutions with an idea of how responsible you are with your money. A poor credit score (around 630 or below) can damage your chances of getting approved for the mortgage. Take steps to improve bad credit before you apply.
Down payment – If you can afford to put down a larger down payment, your chances of approval go up because you’re now borrowing less money. The down payment required will vary depending on the method used to assess your income. If you’re relying on Social Security, pensions and your retirement fund, you probably can get by with putting down as little as 5 percent, although you’ll have to take on private mortgage insurance (PMI) until you reach 20 percent equity. If your income was determined using the asset depletion method, your lender may require a 30 percent down payment. Talk to your lender about how much you’ll be required to put down on the home, and make sure it’s an amount you feel comfortable paying.
Occupancy status – Primary homes usually secure better mortgage rates than second homes. If you intend to use the new home as a vacation property, you should be prepared to pay a little extra in interest.