Does Retirement Make Me a Financial Risk?

17

August 5, 2014 by Jean

2678529Part of my plan for retirement has long been to build an addition on my 900-square-foot home to make it more comfortable for full-time living. I have been accumulating savings designated for this purpose for the past decade, and had about half the funds needed for the construction on hand when work began in June.

I went back and forth about whether to finance the entire renovation project from my savings or to take a loan for part of it and finally decided to finance half the new addition with a home equity loan. This would allow me to live longer on my savings and to delay taking distributions from my retirement funds, which have been growing at a faster rate than the interest on the loan.

In hindsight, I realize that I was naïve about the process of getting a home equity loan. I thought borrowing against the equity in a house that I own free and clear for a project that would add value to that property, especially given my FICO score in the 800s, would be easy; banks wary of making risky loans in the aftermath of the financial crisis should be eager to lend to me. Think again!

After doing some research at Bankrate.com, I chose to apply for a fixed-rate home equity loan from TD Bank, a national bank that I hadn’t done business with before, but that had local branches and the best terms for such a loan. I could have applied for a variable-rate home equity line of credit (HELOC) at a lower rate of interest from my credit union, but the rate was not enough lower to offset the risk of rising interest rates.

My first hint that getting a loan might be more complicated than I had anticipated came about a week after I submitted my application, when I was notified that my loan had been conditionally approved and passed along to a loan processor whose work would take 30-40 days. The first sign of real trouble came when I was providing the requested explanation of how I could be employed in Pennsylvania but have a primary residence in Maine. I explained that I was in the process of retiring and that, while I was still on the payroll of Gettysburg College, I no longer had responsibilities in Pennsylvania and was living in Maine. Since I had explained all this to the young woman who took my application on the phone and that application had already been ‘conditionally approved’, I was not prepared for the alarmed response of the loan processor to the news that I would no longer have a regular paycheck after December. In the days that followed, I provided detailed documentation of my savings and IRAs, 403(b) retirement funds, and budget for retirement living. This, I thought, would reassure them that I was not going to suddenly become a deadbeat when I retired.

But then a new problem arose. The loan processor contacted me to ask whether I was doing a renovation. The appraiser’s report noted a new foundation and work happening at the front of the house, and this had also set off alarm bells at the bank. Yes, as I had explained to the woman who took my loan application, the purpose of the loan was to help finance an addition to my house that would increase its value – exactly the type of project for which all the personal finance experts say that home equity loans are appropriate. And, yes, that project had been proceeding while the wheels of the loan process ground slowly on.

The next move on the part of the bank was to request detailed documentation of my renovation project (architect’s drawings, building permit, etc.) and a much more detailed appraisal, which happened last week. Two days after that, I received an email from the loan processor informing me that “We received the appraisal and it is waiting to be reviewed. The appraiser did indicate value is subject to repairs being completed, so most likely the appraisal will not be approved.” The reference here to “repairs being completed” means the completion of my addition; and if the appraisal is not approved, the loan will not be approved. So TD Bank is not willing to risk loaning me money to build an addition on my house until that addition has been completed!

At this point, I’m feeling like a character in Joseph Heller’s Catch-22. Perhaps Major Major – the young recruit in that novel who was inadvertently promoted from boot camp to the rank of major by a computer error and who dealt with his lack of competence for his job by only allowing people into his office to see him when he wasn’t there – is in charge of lending policies at TD Bank. Although the bank’s decision will not be official until the appraisal has been reviewed, a process that will presumably take several more weeks, I am proceeding on the assumption that my loan application will be denied – an outcome that I never anticipated. Fortunately, I don’t actually need the loan. I can pay for all the construction costs and still delay drawing on my 403(b) funds until 2017 by drawing down my savings and using some IRA funds earlier than I had planned.

The question remains, however, of how much the bank’s response to my application was based on my retiree status. As Dr. Don at Journey into Retirement noted in a post about his own bank loan application horror story, “…[F]rom the perspective of the bank, people going into retirement have no income ….” Dr. Don posted about his experience as a “cautionary tale” to other retirees, and  I wish I had read it before I decided on my strategy for financing my addition. I’ll never know how much my experience was shaped by my retiree status, but I think the caution to all pre-retirees and retirees is that you can’t assume that an excellent credit history will open the same doors for you in retirement that it did beforehand.

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17 thoughts on “Does Retirement Make Me a Financial Risk?

  1. Well…I could wax poetic about being classified as a retiree and a senior citizen, but I’ll spare you and just say how sorry I am about the whole process. 🙂

  2. I wonder if that would be true for me here as I have a monthly pension from the State…sure is a whole other world now. Sorry to hear of this glitch and I would say a discrimination that is painted with a broad brush by some organizations.

    • Jean says:

      Donna, There seem to be two issues that banks have with retirees. First is whether you will have any regular income coming in; your monthly pension should help with that one. The second is whether there are assets that can be used to repay the bank if you default on your loan. As Melanie notes below, retirement savings are protected in bankruptcy and are not available to creditors.

  3. Melanie says:

    Jean: You might want to take a look at this government web site which explains your rights under the Equal Credit Opportunity Act: http://www.consumer.ftc.gov/articles/0347-your-equal-credit-opportunity-rights#apply Among other things, it says a creditor may not consider your age in making a decision on whether to grant you credit, “unless it’s used to determine the meaning of other factors important to creditworthiness. For example, a creditor could use your age to determine if your income might drop because you’re about to retire.” Also consider that the bank may not be able to count on your retirement assets being available to repay the loan if you default (which you wouldn’t!) because such assets generally are protected against attachment by creditors. So yes, it is harder for retirees to obtain credit!

    • Jean says:

      Melanie, Thanks for reminding me that retirement savings are protected in bankruptcy; that is information I had known at some point but then forgotten. Nevertheless, I thought the whole point of a mortgage or home equity loan is that the loan is secured by the house. The fact that this is the only asset the bank could seize in default makes sense of why they would want to have an extra detailed appraisal in my case. It doesn’t explain, however, why they denied the loan, given that the amount I was asking to borrow is about what unimproved lots go for in my neighborhood.

      • Melanie says:

        True, but it is very costly for a bank to foreclose on a property and no bank wants to be in the position of kicking little old ladies out of their homes. Still, you are right to feel something is wrong. Banks are supposed to be in the business of taking credit risks and making loans and indeed are obligated to lend in their local communities under the Community Reinvestment Act. Banks are given special privileges–FDIC insurance and access to borrowing from the Federal Reserve, for example–to encourage them to lend and help keep them sound. Because the government/taxpayers have potential exposure to bank failures, however, bank lending activities are subject to federal supervision and regulation, which has become more strict and resulted in a tightening of credit availability since the financial crisis. Among other things, banking regulators impose requirements for the content of appraisals that banks may rely on in making loans. Many of these regulations are an outgrowth of various abuses and unsafe and unsound practices, which creditworthy people such as yourself and others now are paying for.

  4. Jean says:

    It is a catch-22 to be retired and want to get a traditional loan. It’s so much trouble that half the time seniors just give up and pay cash. After our retirements when we built the house I was able to borrow from my own 401K retirement account and then pay the account back with payment coupons that went right back into my own retirement account. It was like taking money from on pocket and putting it in the other. They only let you borrow up to 30% and if you got tired of making payments they’d take the balance due out of the 401K if you wanted. I have since payed off the loan with my husband’s life insurance but it was a trouble and stress free way to borrow money at the time.

  5. My experience is that there is a huge gap between the neurotic way in which banks deal with any form of private loan – looking at income and not worth – and the business plan based loan on a business account where they take risks. As a ‘farmer’ about to sell my farm I found myself falling between two stools recently when I tried to increase my overdraft facility. Good luck!

    • Jean says:

      Jack, Your experience reminds us that banking is a global business and that my experience does not just reflect glitches in the US credit market in the aftermath of the financial crisis and new, stricter banking regulations. I have heard news reports that in the US, also, the same banks that are extremely strict about residential loans are happy to make risky business loans.

      • Melanie says:

        Not to prolong the topic but contribute factual information, it costs banks twice as much in terms of the amount of risk-weighted capital they must maintain when they make a business loan versus a home loan. The “risk weight” of a business loan under regulatory capital rules is 100 percent but only 50 percent for a home loan, meaning banks have a capital incentive to make home loans. Because of the higher capital cost and assumption of risk when they make business loans, banks typically charge higher interest to the business borrower. Small business loans can be more profitable for banks than home loans if the interest rate is high enough to compensate for the higher capital cost, which is why they make such loans. Large businesses typically do not use bank loans, because of the cost. Rather, they meet their financing needs more cheaply by issuing commercial paper or bonds directly to investors in the financial markets. Small businesses do not have access to market financing and must rely on bank financing. Many small business bank loans are subsidized by the Small Business Administration, making such financing more available. In any case, the bottom line for retirees is just what Jean says–it is wise to consider financing needs when planning for retirement.

        • Jean says:

          Melanie, Thank you for contributing all your expertise to this discussion. I like to have the facts, and it is surprisingly difficult for ordinary citizens (even highly educated ones like me who are skilled researchers) to figure out where to find them.

  6. Charles F. Emmons says:

    Jean, this is a quite fascinating and useful discussion, especially since Penelope and I have been considering investing after retirement in a small apartment building, which we would also live in, in West Chester, PA. Penelope thought we could get a loan for the building, but now I’m not so sure.

    • Jean says:

      Charlie, I would recommend checking this out thoroughly before you retire. It never occurred to me that my 800+ FICO score would not be good enough to get me a home equity loan. I felt better about having my loan application denied, though, when shortly afterward, Ben Bernanke’s application to refinance his mortgage was denied. His comment: “We still don’t have the home mortgage finance regulations quite right.”

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I am Jean Potuchek, a professional sociologist who has just stepped into the next phase of my life, retirement, after more than thirty years of college teaching. This blog is about my experience of that new phase of life.

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