Should You Refinance in Retirement?
With interest rates still at historic lows, but ticking upward, some are wondering whether it's the last best chance to refinance. The question is even trickier for those in retirement.
“I am a fan of everyone getting on this refi train before it leaves the station, and this includes retirees,” says Carol Lynn Upshaw, a vice president with Private Mortgage Services, a division of Private Bank of Buckhead.
It's a decision not to be made lightly though. There are key considerations.
For sure there are plenty of good reasons to refi. “Even a small reduction in a monthly payment can make a big difference to a retiree living on limited income,” says Brooke West, a SunTrust private financial advisor.
Then too, if the mortgage rate is lower than the rate on outstanding credit card liabilities or auto loans, then it may make sense to consolidate those debts into the mortgage. In other words, use home equity during the refinance process to pay off those liabilities. Doing so may further improve monthly cash flow and may eventually improve their credit score, adds West.
But that said, there are caveats. Refinancing isn't as easy these days. In order to get the best rates, retirees have to have stellar credit, along with the ability to repay the loan with stable income and cash available, says financial attorney Leslie Tayne.
“Lenders have routinely rejected refinancing for retirees because they have little or no earned income – even though they may have a seven figure bank account and significant equity in their homes,” says estate planning and elder law attorney Debra Speyer. However, retirees can monetize their retirement assets. “So if your 401k or IRA has, say $700,000, lenders will assign an annual rate or return of around two percent (though it varies by lender). This amount is then counted as income, allowing retirees to take advantage of historically low interest rates,” says Speyer.
Tayne points out another consideration, “Depending on the value of the home, retirees may have less equity when selling the house or passing away. Retirees may not ever decide to sell their house if they refinance, which can be a problem if the home becomes more difficult to pay for and maintain as they get older.”
Do the math. The rule of thumb for refinancing is usually that if you can get an interest rate reduction of at least one percent, with low or no fees do it, says James Poe, founder of Texas Retirement Specialists. Get a complimentary estimated of the proposed new rate and monthly payment, as well as expected closing costs. By dividing the savings into the cost of refinancing, you can determine how long it will take you to recoup the cost of refinancing.
Answer essential questions. How long do you plan to remain in the home? If less than two or three years, it probably doesn't make sense to refinance due to closing costs, which typically take 24-36 months to recoup. “One exception might be if the retiree's children plan to keep the parent's home and/or rent it out if the parents move into an assisted living facility,” says West.
Do you have equity in the home? In South Florida, for example, an individual would need 20 percent equity in the property in order to be eligible to refinance. “If you don't have that much (or any) equity, one alternative would be to ask your lender if your mortgage loan is eligible for the Fannie Mae or Freddie Mac HARP program which allows people to refinance even when they have no, or limited equity in their home,” says West.
Can you afford to refi? “Do you have the cash to do it comfortably? For folks who are really tight on cash, the cost of doing the refi is significant for them and if an emergency arises, they might have to use credit cards,” warns certified financial planner William Hammer.
What's your objective? Do you want to pay off the mortgage as quickly as possible, or to minimize monthly outlay regardless of how long it takes to pay off the mortgage (if ever), especially if you refi for another 30 years? Though “who really cares if the loan is for another 30 years if you get the money for more pressing needs like food, prescriptions, travel. It's about quality of life,” says Joe Chatham, of Chatham Mortgage Partners.
Refinancing can be ideal, even when freeing up cash flow is the primary issue. Linda Sands, branch manager at Luxury Mortgage Corp, is working with a couple in their mid-sixties and semi-retired, who plan on staying in their home for the rest of their lives. They have 20 years left on their mortgage with an interest rate of 4.75%. She's looking for a 15 year loan at around 3% interest for them. They plan to to make additional payments towards principal every month with the target of paying off the full mortgage in 10 years or less. This gives them an excellent interest rate with flexibility on their monthly payments. Even if both stopped working tomorrow, they can make the payments on the 15 year loan at 3%. Says Sands, “If they continue to work and have extra money, they can pay off the loan off more quickly. This refinance makes sense.”
Refinancing can be a smart strategy – a retirement rescue.