I recently retired and would like to buy a smaller home. I start getting Social Security next month, so my income isn't much. I have a lot in retirement savings, which earns interest and dividends. I can also take distributions whenever I want them. Do mortgage lenders count distributions as income? Or should I just forget about financing my home and pay cash?
Interest and dividend income from retirement accounts can be used to qualify for home loans. Here are the five steps mortgage lenders apply to the process:
- Take the most recent two years tax returns or account statements
- Add up interest and dividend income
- Divide by 24
- Subtract any funds in the retirement account that will be used for the down payment and closing costs
- Prorate the average income. For example, if you earn $1,000 a month in interest on $400,000, and you plan to take out $40,000 for your down payment and closing costs (10 percent of your assets), the lender will subtract 10 percent from that $1,000 and count $900 a month in interest income.
To verify your Social Security income, mortgage lenders need a copy of your award letter, since you have not begun to receive the money yet.
To count your retirement distributions as income, mortgage lenders need to verify that the income will continue for at least three years. Your plan may offer several distribution options, including a single lump sum payment, payments over a set period of time (such as five or 10 years) or an annuity with monthly lifetime payments. You might want to consult a very experienced loan officer or underwriter to see how much income you need from distributions to qualify for the home you want, then set it up with your plan accordingly. Get a letter from your plan to give mortgage lenders when you apply for home loans.
Finally, not all retirement income is always taxable--Roth IRA distributions, some Social Security payments, and other payments may be worth more because of this. In that case, your mortgage lender should give you additional credit for non-taxable income (this is called grossing up). A borrower in a 25 percent tax bracket then gets credit for an extra 25 percent of his or her non-taxable income. This can make qualifying easier.