By Nicholas A. Ibello, CFP®, AIF®
You might not have any plans to borrow money once you reach retirement, but circumstances can change. You might need extra funds to cover a major home repair or medical crisis. You might discover a new activity to pursue, such as starting a business or helping a family member with an opportunity. Or, you may want to refinance or purchase a second home. The challenge for retirees is that it can be much more nuanced and problematic to secure a loan once you have left the workforce and no longer have a steady stream of income.
When Your Income is a Factor in Qualifying for a Loan
Lenders tend to view retirees as riskier candidates for a loan, primarily because they don’t have access to the income they were earning during their working years. One of any lender’s first considerations is a person’s debt-to-income (DTI) ratio, which measures the percentage of your current monthly income that goes toward debt. You can calculate your DTI ratio by dividing your total debt payments by your total monthly income.
Total debt payments / Total monthly income = Debt-to-income ratio
Your DTI ratio provides lenders with an indication of how well you’re managing your personal finances. As a general rule of thumb, a high DTI ratio of more than 35% is a red flag for creditors. Depending on your total income in retirement, your DTI ratio can be a limiting factor, either keeping you from qualifying for a loan or limiting the amount you can borrow.
For example, if you pay $1500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2,000. ($1500 + $100 + $400 = $2,000.) If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent.
But the DTI doesn’t tell the whole story.
Plan Ahead with a HELOC
Lending experts agree that one of the best options for having access to cash in retirement is to secure a home equity line of credit (HELOC) before you retire. HELOCs can be very difficult to secure in retirement because income is a key qualifying factor.
A HELOC is essentially a large credit line secured to someone’s home as collateral. Borrowers simply write themselves a check out of the account whenever funds are needed. Most HELOCs only require “interest-only” payments for the first ten years and then require the principal and interest to be repaid over a 10- or 20-year term.
You typically need to have at least 20% equity in your home for a HELOC to even be an option. But you only should borrow what you need, and the line is replenished when you repay it over time. For that convenience, the interest rates are a bit higher than what you might pay on a fixed home equity loan, and may be variable, which could increase your interest costs if interest rates rise. However, no payments are required if there is no balance (similar to a credit card).
How Lenders Look at Retirees
Proving an income when you are working is simple—you collect your W-2’s and paystubs to document your payment history and submit them to the lender. You don’t have to prove that you will be receiving that same income for the foreseeable future.
But this isn’t the case with retirees. When evaluating a retiree’s income, lenders consider if the sources of income will last. That is, do they have a defined expiration date? Is there a possibility the borrower could spend down all their assets or be denied access to their retirement funds?
Borrowing Options in Retirement
Generally, lenders are more interested in your ability to repay a loan than how much money you earn. That opens up a couple of additional opportunities for accessing cash regardless of your income.
Asset Qualifier Loan
An Asset Qualifier is a measure of your ability to satisfy a loan obligation, based on your assets, not your income. So, if you’re over the age of 59 ½, you may be able to qualify for a mortgage or refinance if you have substantial assets. Lenders calculate your “qualifying income” by dividing your total liquid assets by the loan term (number of months). Going further, if you have $2 million in liquid assets in IRAs or non-qualified accounts (such as an individual or joint account) and the loan duration is 15 years, your income is $11,111 for loan qualification purposes.
$2 million / 180 months = $11,111
One important note is that you are not required to actually sell any assets. This method is only used to demonstrate your capacity to repay the loan. To qualify, you must have a credit score of 680 to 700 or higher (lender’s credit score parameters may vary), a DTI ratio below 50%, and you will need to make a down payment of 25 to 30 percent.
Securities Backed Line of Credit (SBLOC)
If a significant portion of your net worth consists of non-retirement investment accounts, an SBLOC can be another viable option. Essentially, you put up your securities as collateral to secure a loan. SBLOCs are non-purpose loans, meaning they can be used for any purpose except buying more securities. Because they are collateralized, their interest rates tend to be lower than traditional loans. They’re also very flexible as they don’t have a specific maturity date or repayment schedule.
Many retirees don’t plan on borrowing money in retirement, but that doesn’t mean they won’t have a need should their circumstances change. As part of their planning contingencies for accessing cash, should the need arise, pre-retirees may want to consider establishing a HELOC on their current home before their retirement. They may never have to use it, but it costs little to nothing to have it in place and only requires repayment if it is ever used. Once in retirement, retirees’ borrowing options are somewhat limited unless they have substantial assets to collateralize, so it’s best to consider the options before saying “sayonara” to your regular wages.