Retirees, the self-employed and many others often find themselves in a fix when mortgage shopping -- they are asset rich and income poor. Without a steady income, how do they qualify for a loan?
It's not impossible, though the requirements can be stringent. Loans backed by Fannie Mae and Freddie Mac -- which means most loans issued these days -- can use assets such as IRAs and 401(k)s to help applicants meet income requirements.
The formula takes 70% of qualifying assets, subtracts what will be needed for down payment and closing costs and divides the remainder by 360, the number of months in a standard loan, to arrive at a monthly income used to determine the applicants' maximum payment and loan amount.
HSH.com, the mortgage-information firm, says, for example, that a borrower with $1 million in assets could count $700,000. After taking out $10,000 for closing costs and dividing by 360, the borrower could show $1,917 in monthly income.
That, of course, is not enough for a gigantic loan. But it could be very helpful if the borrower needed a relatively modest loan for the gap between the cost of a new home and the proceeds from selling an older one. And Social Security, pension and other income sources could help the borrower get a bigger loan.
There are some catches, however. To be counted, the assets, including interest earnings and dividends, cannot be used for current income, HSH says. The applicant also must be fully vested, or qualified to make withdrawals with no penalties such as the 10% early withdrawal penalty for traditional IRAs and 401(k)s.
Lenders don't advertise the asset-based loan option widely, but many do offer them. Start your search by finding loans with appealing rates and fees, then talk to those lenders about this option.
But is it a good idea? Generally, retirees should be wary of carrying too much debt, as older people have less opportunity to find work and ride out a financial setback. On the other hand, loan rates, though rising somewhat, remain low by historical standards, making payments relatively affordable. Savvy investors may figure that taking out a low-rate loan rather than selling assets to buy a home will allow them to keep their retirement investments compounding.
Retirees would be wise, though, to consider other options as well, such as a reverse mortgage or downsizing to a cheaper home.
An asset-based loan can be a very useful tool for the self-employed person who has income that is not reported on a W-2 form from an employer. In recent years, tight lending standards have made it difficult to qualify for a mortgage if income is uneven or comes from sources such as freelancing or consulting fees.
This article was republished with permission from TheStreet.