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Royal London is sounding a note of caution that most interest-only borrowers hoping for a retirement interest-only (RIO) loan to rescue them at the end of their mortgage term face disappointment because they haven’t saved enough into their pension, and so would struggle to meet the ongoing repayments in retirement.
With many thousands of interest-only borrowers coming to the end of their loans in the next few years, and no obvious way of paying off the capital balance, some had hoped that a new interest-only mortgage running through retirement could be the answer.
However, around 12 million people are still not saving enough even to cover basic living costs after they retire, making it unlikely that they will be able to afford the cost of servicing a mortgage debt in addition. As a result, many will find that they fail stringent affordability tests applied by RIO mortgage lenders.
The existing affordability test for a standard working-age mortgage relies heavily on the income of the highest earner or joint earnings. In retirement, the lender must look at how the mortgage interest will be paid after one partner dies. This means that it is the income when one partner becomes a widow or widower that determines if the mortgage is affordable. With many pensions stopping when someone dies or passing on only a modest percentage to a surviving partner, a mortgage that may seem affordable when both partners are still alive can become unaffordable if one dies.
According to the Financial Conduct Authority, around 10% of interest-only loans are not backed up with any repayment plan, while 50% are likely to have a shortfall. There were 550,000 interest-only mortgages borrowers over the age of 55 in December 2018, representing about a third of the total 1.66m, according to UK Finance.
Becky O’Connor, personal finance specialist at Royal London, said: “The introduction of RIOs may give false hope to hundreds of thousands of borrowers with interest-only loans they can’t pay off at the end of the term.
“These loans might seem like the perfect solution, but in practice, because of affordability criteria, they will not be the answer for most people.
“Pensions are not designed to cover housing costs. ‘Target pot’ estimates assume that people who are homeowners have already paid off their loans and will only need to cover other essential living costs, like food and energy bills, in retirement.
“With many people not saving enough in a pension even to cover basic living costs in retirement, many borrowers are likely to have an application for a RIO mortgage rejected or be offered a much lower amount than their shortfall.”
This suggests up to 275,000 borrowers who are already at or approaching retirement face choosing between downsizing; working for longer, taking out an equity release loan or applying for a RIO loan in order to avoid repossession.
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