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Millions of Americans in or approaching retirement face a scary financial picture, having little in retirement savings and some still facing sizable mortgages on their homes. Yet even those who have planned well for their retirement by building up substantial nest eggs still deal with financial challenges that those who are still working don't have to face.
One recent move from the government-sponsored enterprises responsible for a large portion of the mortgage market has the best of intentions in trying to make things easier for seniors. By taking into consideration a source of income that has until now been off-limits, however, it's possible that the move could backfire on retirees by stretching their limited financial resources even further.
The challenge of retiree mortgages
Recently, Fannie Mae (NASDAQOTH: FNMA ) and Freddie Mac (NASDAQOTH: FMCC ) made it a little easier for retirees to get new mortgages or to refinance their existing mortgages. By changing the rules for what a lender can consider as income to include retirement account balances in IRAs, 401(k)s, and similar accounts, the mortgage agencies hope to make it easier for low-income seniors to make beneficial moves like refinancing existing debt to capture low interest rates or moving from a large family home to a more modest home to free up locked-in home equity.
Before the rule change, the problem that retirees faced was that their incomes didn't necessarily reflect their financial resources. If loan officers only looked at Social Security benefits or traditional pension payments, they might reasonably conclude that a retiree had insufficient income to cover monthly mortgage payments and therefore deny their loans. That in turn prevented retirees from saving money by refinancing and made it difficult to get a mortgage for retirees who wanted to move into a smaller home to save on expenses.
What the rule does is to allow lenders to consider retirement-account balances in offering mortgage financing. Under the rule, the lender discounts the value of your retirement assets by 30% to reflect potential market losses. It then allows lenders to divide that amount over the span of a 30-year mortgage and add it to your monthly income in assessing whether the resulting debt would meet requirements on debt-to-income ratios.
More housing gimmicks?
There's no doubt that Fannie Mae and Freddie Mac have good intentions in trying to facilitate retiree mortgages. In many cases, the benefits of allowing these transactions to go forward greatly outweigh the risks involved.
Unfortunately, those who lived through the mortgage crisis know all too well that good intentions paved the road to the housing boom. A decade or more ago, innovations like interest-only and negative amortization mortgages were designed to help borrowers qualify for loans large enough to help them afford the skyrocketing prices in many hot real-estate markets. Only later did homeowners realize that the assumptions behind those products were flawed, leading to millions losing their homes.
The same threat exists with the new retiree mortgage rules. By spreading out retirement assets over a 30-year period, the agencies assume that retirees will be prudent in spending down that money. Yet especially for those with more modest retirement-account balances, unforeseen circumstances often make them spend down their savings much more quickly than the assumed 30 years.
In addition, while a 30% haircut might seem large enough for conservative retirement portfolios, regulators clearly have too short a memory to recall the market meltdown of 2008 and 2009, during which the S&P 500 plunged well over 50%. Admittedly, retirement portfolios shouldn't be invested entirely in stocks, but the rule doesn't appear to mandate that retiree-borrowers follow any specific investment strategy.
Finally, with the agencies allowing these loans, lenders will have every incentive to make these loans, knowing they can then resell them to the agencies. Already, rising rates have led to fears of declines in refinancing volume at Wells Fargo (NYSE: WFC ) , JPMorgan Chase (NYSE: JPM ) , and US Bancorp (NYSE: USB ) , as well as a number of smaller lenders across the nation. Without addressing the moral hazard involved in these loans, new rules from Fannie and Freddie could easily do more harm than good to retirees.
How to handle housing in retirement
With proper protections, Fannie and Freddie's rules could make a big positive difference in the lives of many retirees. But as written, the rules appear to be too simplistic to address some of the potential difficulties that could arise. After years of strife, the last thing that the housing market needs is another crisis centered on the most financially vulnerable homeowners in the nation.
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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.