Carrying a mortgage into retirement can be a significant burden. Retirement is supposed to be a time of fun, relaxation, and stress-free living; a time when you can enjoy the rewards from decades of work, saving, and sacrifice.
But it’s also a time when incomes decline for most people. When we retire, we lose the benefit of a regular income from a paycheck. All the while, the potential costs of living, including healthcare costs, continue to increase. This puts a strain on many retirees’ finances.
Add in a mortgage payment, and retirement income can be stretched thin.
Completely eliminating the income may not be possible for everyone, but you may reduce your monthly bill through refinancing. At a time when interest rates are extremely low, refinancing could potentially save hundreds of dollars a month.
Refinancing Your Mortgage When Retired: What are the Advantages
There are numerous reasons why someone might consider refinancing their mortgage. When retired, we see two common motivations for this measure…
Low Interest Rates Bring Massive Advantage
The most common reason, especially in today’s market, is to take advantage of extremely low interest rates. While interest rates depend on other factors like the borrower’s credit and debt load, at the time of writing this article, typical interest rates are running below 3%, sometimes below 2.5%. This means the cost of borrowing money for a mortgage purchase is currently low, yet many retirees are still paying on a mortgage that was taken out 10 or 20 years ago, when interest rates were higher.
Suppose you took out a 30-year fixed-rate mortgage in 2006. At this time, you likely had an interest rate of 6%. Now, you may be able to refinance to as low as 2.5%. In this scenario, you would have 15 years left on your mortgage, and let’s just say you have a balance of $250,000 remaining on the loan. Using our mortgage calculator, we see that a 15-year loan (which is remaining in this scenario) at 6% means a total monthly payment of $2,109.64.
But if we keep all other factors the same and simply reduce the interest to 2.5%, the payment drops to $1,666.97, a savings of roughly $440 a month. This is a significant amount for many retirees.
The above example (which we admit was heavily simplified) does not accurately reflect the savings of a refinance, as many other factors are involved. It does, however, highlight the outstanding potential savings that could be realized by refinancing into today’s low interest rates.
The other motivation for refinancing is to turn some of your equity into usable cash. As we said earlier, many retirees simply don’t have available cash to use for purchases, even though they have a strong net worth. They may own all or a major portion of their homes, yet not have cash for home repairs, medical expenses, or transportation costs like a new vehicle. With cash-out-refinancing, you may be able to get the cash you need.
With cash-out-refinancing, you can essentially refinance your loan and turn some of the equity into cash.
What are the Downsides?
There are downsides to refinancing as well. Mostly these have to do with the costs. Refinancing, like any loan, has added costs and fees, which can total around $10,000 in expenses. This cost needs to be weighed against the potential savings of the loan.
Generally, the longer you have left on the loan, the more you can save by refinancing to a lower interest rate. So, if you only have five years (give or take), the monthly savings may not compensate the costs.
Using Annuity and IRA as Income
The core process of refinancing is essentially the same as the process for taking out a purchase loan. Some of the details will change, but essentially the lender looks at your financial picture, credit, debt load, and other factors to see if you can afford a new mortgage or if you would benefit from a refinance (Generally there needs to be a quantifiable gain from refinancing).
But this creates an obvious issue: income for a retiree. Many retirees, while financially stable (even wealthy) do not have a regular income. Instead, their net worth is locked in property, possessions, and retirement accounts. Fortunately, there are ways to use retirement accounts like IRAs as an income source on the loan.
For IRAs and some other account assets, you will likely be able to use 70% of your accounts, minus roughly $10,000 in fees, divided by the total number of months on the loan.
If it sounds complicated, don’t worry, it’s really not.
Suppose you have $2 million in an IRA account. The first step would be to calculate 70% of this total, which is $1.4 million. This reduction is to account for market volatility. While most accounts will go up, there is always a chance for economic slowdowns or poorly managed assets. To compensate for this risk, 70%, instead of 100%, is used in the calculations.
$1.4 million would then be reduced by $10,000, which is the typical amount for mortgage fees and expenses. This reduces the number to $1.39 million.
Now we can calculate your monthly income by dividing $1.39 million by the total number of months in the loan. If the total loan is for 15 years, the number of months is 180; for a 30-year mortgage, the total is 360. So, if you are refinancing to a new 15-year mortgage, you would divide $1,390,000 by 180, leaving us with $7,722.22. This number could then be added to your annual income.
As you can see, this little retirement hack can work wonders, helping you qualify for a top-quality mortgage even if you don’t have a regular income.
Get the Service You Need on a Top-Quality Loan
If you want to learn more about the advantages of refinancing your loan, contact our staff today. Whether you are in retirement or starting your first job, we can help you find the right mortgage loan for rewarding, affordable homeownership!