When we think of loan qualification, we think of credit scores, debt-to-income ratio, and annual salary totals from a steady career. We rarely think of the money locked in an Investment Retirement Account (IRA), 401(k), or Keogh retirement account.
For many seniors and retirees, however, the main portion of income flows through these sources. In the past, it was extremely difficult, if not impossible, to use these retirement funds as sources of income towards a loan. However, thanks to rule changes from the nation’s largest lending source, Freddie Mac, retirement or pension income, as well as retirement assets, can now be used to qualify for a loan.
While the regular distribution of payments must come at least once a year (monthly is fine, but every-other year is not), and assets set aside for income cannot be doubled for closing or reserves, the new regulation opens up mortgage loan possibilities for millions of Americans across the country.
The Use of IRA Distribution as Income to Qualify for a Home Loan
Why the Change in Rules?
Like many of the financial issues currently affecting our county, it has a lot to do with the Baby Boomer generation. This generation is heading into retirement; many are in fact already happily retired. As millions of American reach retirement, their work-a-day paychecks will end; they’ll now be dependent on social security, pensions, 401(k)s and IRAs. Recognizing this trend, Freddie Mac realized it needed to adjust loan regulations to ensure these retirees could borrow money for a loan when needed.
The plan is intended to provide a boost to seniors and retirees who are seeking a loan but may not have the regular income, despite financial stability.
The new rules mean that a senior with hundreds of thousands of dollars in a retirement account can use these assets to qualify for a loan.
Like all loan qualifications, proper documentation is essential. To use IRA distribution for your loan, you’ll need to verify the income with evidence of consistent payments. Exactly which documents you use can vary depending on the source of the income, as well as the frequency of the payment and the exact methods of payment. (For example, paper checks or direct deposit.)
If payments are currently being received, then at the very minimum you will be required to provide proof that you consistently receive payments, with bank statements, check stubs, and other equivalent documentation. You should provide documents that shows you have received these payments on a regular basis within the past 12 months.
In addition to the payment documentation, you must also provide one of the following documents:
• Written verification from the organization paying the income
• Copy of the most recent award letter
• The past two years of personal tax returns
These documents will be used to verify the types of income you receive, the source, the amount, and the frequency. Whichever you use, make sure this information is stated within the document.
If you don’t have specific evidence that the account as been set up for formal distribution of payments, you do have some options. For distributions that come from a 401(k), IRA, and Keogh retirement fund, simple documentation that you are required to take minimum payments is acceptable, but only if you are unable to provide the documents that we discussed earlier.
If you are receiving a retirement income in the form of an IRA, 401(k), or Keogh retirement account, you’ll have to provide verification through various forms. First of all, you’ll need verification of the funds being used. Next, you’ll also have to demonstrate that you have unrestricted access, without penalties, to the accounts in question. If the assets are non-liquid, such as stocks, bonds, or mutual funds, then you can only use 70% of their value towards your loan qualification. (This is 70% of the value left after all potential deductions.)
In addition to the two documents, you’ll also need to verify that the income will continue for a minimum of three years. If the retirement income will cease within the next three years, it will not qualify as a source of income towards your loan.
IRA Distribution: Understanding the 70% Rule
One of the most important elements of the new guidelines is the 70% rule that we mentioned above.
Here’s how it works:
For simplification, let’s say you have $1 million in eligible assets. 70% of those assets would qualify towards your loan, but it doesn’t end there.
Take the $700,000 (70% of $1 million) and subtract estimated real estate closing costs, which we’ll say is $10,000. This bring the available total to $690,000. That amount is then divided by 360, which is the estimated number of months in a standard loan term (30 year mortgage = 360 months). This brings the monthly available income to roughly $1,917. ($690,00 / 360 = $1,916.67) You can now add about $1,917 to your monthly stated retirement income when seeking a loan. Think about that for a second. That’s almost $2,000 that you can add to your monthly income thanks to the new rules. This can mean a significantly larger or higher-quality home to enjoy during your retirement years!
What About a Down Payment?
There is an important stipulation to using your retirement funds as a source of income. In many cases, you’ll need at least a 30% down payment if you’re using the mortgage loan to purchase a new home. This is a substantial down payment, but it is part of the rules to help protect lenders against the increased risk of borrowing money against retirement funds.
If you are refinancing your current home loan, you’ll need at least 30% equity in the property, which once again helps against risk.
Using IRA Accounts Before Retirement Age
If you have structured the account ahead of time, you can actually use IRA accounts if you retire before the mandatory withdrawal age. You must, however, meet specific requirements. You must have started receiving the withdrawal payments for at least two months, and you must be able to continue withdrawing, at the same rate, for at least three years without maxing out the account.
“Chad – Your team has been nothing short of amazing. Juliann has aggressively followed-up with escrow and gone out of her way to make sure things get done on schedule. Matt and I can’t express to you enough how much we’ve appreciated all of your counsel at the beginning of the process and her execution to see it through to close. As always, appreciate everything that you guys have done to see this through.”
Chad Baker and his team are amazing!
My husband and I found Chad through an article he had written. Every aspect of working with Chad and his team was exceptional. From our initial phone call where he explained the many options we had, to advice he gave in dealing with somewhat challenging sellers, and closing our loan ahead of schedule, the loan process with Chad and his team went very smoothly. I especially appreciated the one-on one guidance from Juliann, who really made me feel like I was her only client. I look forward to working with Chad and his team again and would highly recommend them to anyone looking for a mortgage.
“We’re loving our new place and we’re very pleased with how smoothly everything went through closing. Thanks for keeping us up to date on the possibility of refinancing at a lower rate; we trust your judgement as far as waiting until the rate is around 5% lower before we refinance. We’re very interested in pursuing that if rates drop to that level. Thanks so much for all your help and personal attention!”