Ask the Expert: Taking loans in retirement

[pattyl11]

My spouse and I retired at 65 and 63 respectively. We own our 2 1/2 story home built in 1991 and we have $60k in debt on our first and second (HELOC) loans. Our first loan will be paid off in 9 months, at which point we will accelerate paying off our second. We had planned to do a lot of travel pre-pandemic, but with as much time as we have spent in our home the past 2 1/2 years, we decided to invest in making it more comfortable. I broke my hip and my spouse is experiencing back pain issues, so we decided to add a bedroom/guestroom/bathroom suite onto our main floor, accessible via a ramp from the garage; we are two months away from completion. We were hoping to defray taxes on our IRA withdrawals, which we have used to fund the remodel, so refinancing seemed like a great option. The challenge is taking a loan in retirement - we were hoping to take out a loan for approximately 1/3 of the value of the house to update the interior, replace the deck, and update the landscaping. Despite considerable assets (> $1M) and very high credit scores (> 820), the underwriter is pushing out the closing based on a "final appraisal", which means we may lose our locked in rate of 4.25%. This would be our fourth refi with our lender, with whom we have had a perfect payment history. It’s ridiculous for retired people to be required to show 3 years of employment moving forward – they would also not consider insurance policies (I am insured for $250K, spouse is not) and we could start withdrawing $5K in social security per month tomorrow if we wanted to. We had to demonstrate that we were making IRA withdrawals of $11K per month and had enough funds to do this for three years; this was still not enough to satisfy the underwriter. The appraisal comps were 50-60% of our appraisal, which would have been higher if we had done more updates. Some 401k plans allow you to borrow against your funds; I read online that retired folks can borrow $50K and repay within 5 years, though it says sometimes the repayment terms can be extended. Our Fidelity advisor encouraged us to roll our 457 and 401k plans into IRAs, since IRAs offer more funding options. What he didn’t tell us that once we had rolled them over, we could no longer borrow against our IRA (SEC rules?), only against non-IRA accounts. So retired folks are really limited in terms of what they can borrow even if they have ample funds to safely do so, and this feels discriminatory with respect to lending rules and regulations. Is there some AARP advocacy effort that can be made to help retired borrowers?

[GailL1]

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@pattyl11 wrote:

 Is there some AARP advocacy effort that can be made to help retired borrowers?

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I can't answer your question to AARP - not sure how much AARP gets into government / lender and IRS rules and regulation.  

This is kind of long but hopefully it will shed some light on your predicament and give you some information that you might not have thought about. 

I just wonder why you did not use your HELOC to do such a major renovation?  

As with anybody else, regardless of age or employment status, lenders will look at the income that you have coming in and the amount / obligations which you owe to any creditor, along with your credit score to determine their approval of a loan.

Just a guess, but at this time, you may also be involved in a lender approval slowdown if you have a locked in rate of 4.25% with current mortgage rates running over 5% now and those will probably be going up since the FED is probably going to continue to raise rates in order to slow inflation.  The other thing is right now, home values are in flux because of the changes in the marketplace - the buying frenzy which had pushed up values is now cooling off - drastically.

Using or borrowing from one's retirement account is never a good way, IMO - doubly so, if one is in an upper age category and is no longer working.  

No, you cannot borrow against an IRA - per the IRS - Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Loans are only possible from qualified plans that satisfy the requirements of 401(a), from annuity plans that satisfy the requirements of 403(a) or 403(b), and from governmental plans. 

You also cannot rollover any outstanding loan balance from another type of (employer) retirement plan to an IRA.  In fact, that action could even disqualify the IRA transaction completely by the IRS. (see the same IRS link above)  If you do borrow from an IRA - the IRA is no longer classified as an IRA and the whole amount could be then classified as income and taxed accordingly.  It cannot be pledged as collateral.

You may want to review that IRS (FAQ) page in total to make sure you understand what one can and cannot do.  Even the sponsor of the type of plan (457 / 401K) which you may have may limit the loan capabilities in their plan - read your individual plan documents.

You also said:  

We were hoping to defray taxes on our IRA withdrawals, which we have used to fund the remodel, so refinancing seemed like a great option. 

. . . . We had to demonstrate that we were making IRA withdrawals of $11K per month and had enough funds to do this for three years; 

You maybe messing with fire here - all that is gonna be classified as income and there will be tax consequences as you know but the other real problem is the amount that you and your hubby will have to pay for those Medicare Part B premium & premium surcharges (IRMAA -  Income Related Monthly Adjustment Amount) which are based on income - actually the income one reports (2) years before.

Medicare.gov Part B Cost

Be Careful.

Also if your lender / potential lender is seeing that you are taking money from your retirement account now even though you say it is to pay for this major renovation - it will appear in numbers that you are using this as income that you need and thus they will forecast the same amount for the long term.

Again, Lenders go by numbers / income / other financial obligations / credit score / appraised value less what is owed - how you manage your money is not what they consider.

It seems that you are gonna have to do some real planning here and maybe put off the rest of the renovations until the house main mortage is paid off - then apply for a new HELOC - roll into it what is left from the other one and then you will have access to at least 80% of the equity (at the time)  

Again, these are just points to consider. 

I am WAY older than you, been retired for over a decade, home about the same age, but I just got a new HELOC with No problems; in fact it was done in record time.  I will use it only as needed for anything that may come up where I don't want to spend or tie up the cash upfront - like a new roof - so it's not the age - it is the income and home value less what you owe on it that seems to be causing the problem.  Sorry.

 

[CarminB315552]

Unfortunately, I am not personally familiar with the AARP organization. But I have heard that this organization aims to improve the quality of life as we age. AARP provides discounts for health, travel, benefits, services, and various job resources. I was interested in your question and started researching if any efforts can be made to help retiree borrowers. However, I didn't find anything. It may be helpful for you to contact a financial advisor for medical professionals who can give you professional advice. I wish you all the best.

[pattyl11]

AARP does have advocacy groups who work with Congress to safeguard seniors. Our HELOC is already maxxed out after a kitchen remodel and two bathrooms and we owe $62K total, $12K of that is our first; house appraised at $880K. We have zero owed outside of 1st/2nd and we pay off our credit cards in full every month. We've already considered all the points you mentioned, especially the tax liability and me approaching 65 in 18 months. Borrowing from my 401k and paying myself a better rate than the market seems like a safer bet than where my IRA has been headed the past six months. That was the whole point of doing the refi - to avoid the tax liability. We can instead apply for a new fixed rate HELOC, since ours expires after 10 years and we are almost there. We were planning to pay off the refi in 5 instead of 10 years. 

[GailL1]

Then it seems that the delay in approval or denial is that slowdown due to rates rising and the flux in home values. 

If that is the case - I'm wondering if a new HELOC would be more to their (approval) liking since it is an adjustable rate.  The feasibility of this would all come down to what the appraisal comes back as and then 75% - 85% (or sometimes more) of what they will set the HELOC amount as, less what will be rolled into it based on your old HELOC balance.  

@pattyl11 said:

AARP does have advocacy groups who work with Congress to safeguard seniors. 

Maybe the AARP Foundation or via their lobbying efforts but I don't see any problem here.  Lenders cannot discriminate based on age or even if you are retired - it has to be something else that is slowing down the works.  At this point, what that might be is up for grabs.  It is the lenders money - they can exert financial caution without discimination - could be something about the house and its value.  

Credit scores are a good indication of your past history with credit but in the end, they are looking at income and your obligation more than anything else.  Paying off your credit cards every month (that's in your credit score) is great, but they will also look at your available credit which could also be or turn into an obligation.

When do you expect the final appraisal?

[pattyl11]

Thanks for your responses. The underwriter asked if there were exterior walls missing and I sent a drawing - however, those walls are now up and fully framed, siding is up, electrical/plumbing rough in complete/inspected, insulation is in/inspected, roof is on, and doors are on all exterior walls. Windows go in today.

I did inquire about a new HELOC and max amount (variable or fixed) and I got a response from my lender about the refi: "we are working with the appraisal company to resolve and hope to have an answer this afternoon." Fingers crossed! Final appraisal is not yet scheduled since final walk through is still another two months away. 

We do get an area flyer from our original realtor and the local housing market is very hot (northern Colorado). The sq ft of a $1M house in our area went from >7000 sq ft to ~3300 sq ft, and we are already at 3900 and adding 800 sq ft. Lake front, walkout basement, 1/3 acre, 3 car garage in a cul de sac. 

[GailL1]

@pattyl11 

Yep the house does have to past muster in order to get a loan - all those things you mentioned could have been holding up - 

So, it sounds like you maybe good to go - not sure about keeping that 4.25% rate - but if not, hopefully not much higher - guess you could buy down the rate but that seems like a waste of money.  

Good Luck - hope you enjoy the new / old place.

[pattyl11]

Thanks so much! Appreciate the gotchas (taxes) and the encouragement. I still think that AARP could do some advocacy in the lending department to make it easier for retirees to tap into the equity in their homes if they choose to. And BTW, I absolutely loved Gilda aka Roseanna Roseannadanna. 

[sktn77a]

In general. it's not a good idea for most people to take out loans if you have access to funds of your own ("considerable assets > $1M"), especially in retirement.  Is there any reason you don't want to use your existing funds?

[pattyl11]

Taxes, obviously. IRA is not a Roth.