Should you refinance before retirement?

Erik J. MartinThe Mortgage Reports Contributor

January 12, 2022 - 7 min read

Pros and cons of refinancing your mortgage loan before retiring

Many homeowners nearing retirement strive to pay off their mortgages and enter the golden years with as little debt as possible.

But with mortgage interest rates still competitively low, many are rethinking this conventional wisdom — especially in today’s financial reality where many older adults will enter retirement with debt, refinance or not.

If you need money in retirement, refinancing your home may be a beneficial way to raise cash.

Benefits of refinancing before retirement

In the past, retiring with the mortgage paid was a lifelong goal. But many contemporary retirees have new attitudes around mortgage debt than previous generations.

For some, home equity is a financial tool.

Here are a few reasons many are considering a refinance ahead of retirement:

Rates are still favorable: Although mortgage rates are beginning to recover from their previously record low status, they’re still lower than the double-digit rates that many older adults may have experienced years ago as home buyers
Reduce your monthly expenses: Depending on your current loan, if you refi to pay off a mortgage with a higher interest rate and do not take out cash, you may lower your monthly mortgage payments. This could increase cash flow to pad your retirement savings or other personal finance goals
Refinancing today is cheaper than a reverse mortgage tomorrow: In addition to higher interest rates, reverse mortgages will generally carry higher upfront costs to close the loan, too. Cash-out refinancing before retirement, while you’re still employed, may save money in the future, especially if you suspect that you do not have enough retirement savings to cover expenses like medical costs or long-term care
Your income is higher: Underwriting a conventional loan is generally easier when you have employment and monthly income, as opposed to when you’re retired and without a traditional salary

Refinancing goals for older homeowners

There are several common ways to refinance before retiring:

Leverage your home equity with a cash-out refinance
Refinance into a new loan with a lower interest rate
Extend your existing mortgage in a new 30-year loan
Shorten your loan term to a 10 or 15-year mortgage

Each of these loan options come with advantages and disadvantages. Understanding which makes sense for your financial situation will be crucial for a positive experience.

Should you wait until retirement to refinance?

Waiting until retirement to refinance your mortgage loan is an option. Yet, if your income drops after retirement, you may have difficulty qualifying.

Mortgage lenders use a borrower’s income to determine whether or not they can repay a new loan. They’ll also examine your debt-to-income ratio (DTI) and credit score to ensure that you’re a candidate for loan underwriting.

Since retirees generally do not have a monthly salary, you’ll need to qualify for a refinance with funds from Social Security, pension, and other forms of income.

Consider a cash-out refinance before retirement

Do you own a home in your 50s or older and still have a mortgage? Maybe you should consider a cash-out refinance before retirement. This option could offer some flexibility:

Use the extra money to invest in your retirement savings, make a large purchase, or remodel your house
You may pay less if you opt for an adjustable-rate mortgage and plan to move soon
It can enable you to pay down other high-interest debt and streamline all home loan payments

Tapping your home equity before retirement has its drawbacks, too. You’ll be retiring with extra debt. The costs may outweigh the benefits, and tax consequences may apply.

So weigh your choices carefully. Consult with lender, tax, legal, and estate planning experts before taking the plunge.

Advantages of a cash-out refinance before retiring

If you’re nearing retirement, but still make monthly mortgage payments, refinancing that loan may be a smart move. That’s especially true if you can get a lower interest rate or shorter loan terms.

But it may also make sense to tap into the equity of your home. A cash-out refinance before retirement can:

Help you save for retirement: You can use the cash-out money to invest in your retirement accounts such as your 401(k), IRA or other retirement plans. “It’s fine to take cash out of your home at lower rates if you can reinvest that cash at a higher rate,” Realtor and real estate attorney Bruce Ailion “But to borrow at around 5% and reinvest in something like Treasury notes at 3% doesn’t make sense.”
Increase your cash flow: That extra money can help fund a remodel, auto purchase, tuition, medical bills, and more. “For example, maybe you need a remodel in the next few years. Well, you may want to take care of it now. That’s because you may have a harder time qualifying for a refi, home equity loan, or home equity line of credit (HELOC) later,” says Jennie Jacobson, mortgage loan consultant with Orange County’s Credit Union
Possibly lower your monthly payments: Plan to move within a few years? Then it may pay to refinance to an adjustable-rate mortgage that offers a low introductory interest rate period. This period should match the time you plan to remain in the house.
Consolidate and pay off debt: You can use the extra cash to pay down other high-interest debt. “Your cash flow can improve if you eliminate unsecured credit card debt. That’s because this kind of debt usually has high monthly payments,” Jacobson says
“Free” money for retirement: When you owe little to nothing on your home, refinancing can be advantageous. “If your mutual funds or stocks are bringing home average annual gains greater than that of the interest rate you would be taking, you can essentially get some free additional money for retirement,” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO

Cash-out refinancing to build up your retirement accounts can be risky at a time when many experts and financial planners advise safer investments that preserve your capital, rather than aggressive ones that can pay more, but also lose big.

Disadvantages of cash-out refinancing

Taking money out during a cash-out refi isn’t a foolproof plan, and there are drawbacks:

It can cost more than it’s worth: Refinancing involves closing costs. These can equate to around 2%-5% of the loan amount. Experts advise avoiding a refi if you expect to sell your home within five years.
You may need to move sooner than you think: “I find many retirees and pre-retirees are in homes that are not ideal,” says Ailion. “The home you bought 10 or 20 years ago may not include aging-in-place features that will allow you to live comfortably. Before taking on more debt from a new loan, evaluate where you want to live and what your needs are.”
You may be in debt well into retirement: Let’s say you’re 60. If you take out a new 30-year mortgage, it won’t be paid off until you’re 90. If you don’t make it that long, your heirs are on the hook to pay off the mortgage.
Mortgage interest may not be tax deductible: “Interest on cash-out refis are now deductible only if the money is used for home improvements. Assume you use the cash to pay off old debt or supplement retirement income. In this case, you won’t be able to deduct the mortgage interest from your taxes,” says attorney Elizabeth A. Whitman. She notes that this applies only if you itemize your tax deductions.
It may impact your Medicaid eligibility: “Maybe you have limited income and are facing medical issues or nursing home care. Cash in the bank from a cash-out refi is not exempt,” adds Whitman. “It needs to be spent on eligible living expenses or medical care before you are eligible for Medicaid.”
You may get hit with a prepayment penalty: Some mortgages slap on fees if you prepay before the loan term expires. Check your loan documents carefully.

Rate-and-term refinancing

A rate–and–term refinance allows borrowers to alter their existing loan’s rate, term, or both.

The goal is to save money either by lowering your monthly mortgage payment or paying less mortgage interest overall with a lower interest rate or shorter loan term.

For example, a homeowner may refinance:

30–year mortgage into a 15–year one
30–year fixed–rate mortgage with a 5% interest rate to a new 30–year mortgage with a 3% fixed rate
From a 30–year fixed–rate mortgage with at 5% to a 15–year fixed loan at 3%

Considerations when extending your loan term

Not sure you can afford the monthly mortgage payments on a shorter-term loan? There’s no shame in choosing a 30-year fixed-rate loan.

“You can always pay extra each month or year to pay off your home loan more quickly if you have the extra money to do so,” suggests Jacobson. (Check that there’s no prepayment penalty first.)

Remember: choosing a 10- to 15-year loan can result in higher monthly payments. “And that may not be affordable after you retire,” Jacobson says.

Also, if you plan to sell your home shortly after refinancing, don’t sweat it.

“You can choose to sell whenever you want to,” notes Jacobson. “But there may be an early termination fee or pre-payment penalty for some loans. Ask your mortgage lender about products that are better for the short-term. These can have a slightly higher interest rate but no closing costs.”

Refinancing alternatives for retirees

Cash-out refinancing doesn’t always make sense for homeowners nearing retirement age. But if you’re interested in tapping your home’s value, there are other loan options.

Rather than borrowing a lump sum of cash, home equity lines of credit offer funds that you can draw from as needed. HELOCs typically feature either low or no closing costs, as lenders often cover the origination fee.

Much like a credit card, HELOCs extend credit when needed, but only over a set period of time, called the draw period.

Make an informed choice

The good news is that mortgage lenders cannot discriminate against you based on your age.

“But they can underwrite based on income and ability to pay back the loan,” says Whitman. “Let’s say you have a lower income today. Then the amount of loan you may qualify for could be smaller and on less favorable terms.”

For these and other reasons, get advice before making any lending decision. Determine if your new mortgage payment will strain your budget once you retire.

“Talk to a loan officer, CPA, and investment professional,” recommends Jacobson. “The most important question to ask is: Is this new loan better than the existing mortgage I have now? If the answer is yes, you can evaluate the costs and feel more confident about your decision.”