Interest only mortgage + pension

mixmastermike

Sorry for the duplicate but I posted in the wrong forum -

Hi

I'm looking at getting on the property ladder within the next couple of years and trying to work out what the best method would be. My preferred method is as below but I'm not sure if I'm missing something.

I'm 30 years old with a plan to retire at 60. I'm also a higher rate taxpayer. I currently put 27% of my gross income into a defined contribution pension (9% personal + 18% employer).

Surely my best option would be to get an interest only mortgage, and up my personal contribution into my pension pot, benefitting from 42% tax+NI relief. Then at 60 take part of my pension as a cash lump sum to pay off the mortgage.

Thoughts?

holly_hobby

Here's Halifax's stance on pension backed IO arrangements ...

"For the purposes of backing an interest only mortgage, a maximum of 25% of the current fund value with the current value to be greater than £1 million.

Where customers are on a final salary pension scheme the lump sum can be used if it is greater than £250,000. Pensions can be combined to reach the £250,000 and there is no need for confirmation of the full fund value."

In both cases they also want the latest (within 12 mths of app) projection statement

Some lenders don't accept pension backed IO, some limit the max ltv at under 75%, whilst some lenders (and bound to increase further over time) don't accept IO at all.

You also have the issue if your employment changes, and/or your final fund value (due to reduced contributions/poor growth or both) despite otherwise healthy projections, will not be sufficient to meet the mge (think of the issues mge endowment peeps have had with bouyant projections, but poor growth).

And finally, you have the Chancellor and HMRC issue that they may continue to tinker with the associated tax benefits/contribution and TFC limits - which again could leave you in a fix with regards to repaying your mge .

Personally, due to the above and continued uncertainity on future changes, I would consider keeping my pension separate from my mge and for it to instead fund my retirement.

The views of other posters may differ, and the above comments are just my considerations that I would make to any client or friend considering a pension mge.

Hope this helps

Holly

mixmastermike

Hi Holly,

Thanks for your reply. I will certainly have to give this a lot more thought. It sounds a lot less of a no-brainer than I first thought

katejo

I am also on an end salary pension scheme and should get a lump sum . It has never occurred to me to rely on that sum to fund my house purchase . I want it as available cash for other plans after retirement . My mortgage is a repayment one and will be paid off by the time I reach 65 .

hugheskevi

As a higher-rate tax payer, planning to use a pension to pay mortgage is extremely efficient, especially with very low interest rates meaning you would expect to get the tax relief and also investment returns to exceed interest rates.

That is what I am doing, but there are risks. Based on my experience, a few things to consider:

• Plans change, but once money is in a pension it is committed. You need other sources of assets for flexibility, so don't get too concentrated into pension investments
• For best rates, you will be wanting 25-40% LTV. That will erode efficiency of using pension, but is a decent balance between efficiency and security of decent asset base
• You can always increase borrowing mortgage later (using that to fund pension contributions if you like), so you may wish to view the mortgage as succession of 2/3/5 year blocks rather than making plans over a 30 year horizon. Particularly as no matter how carefully you plan things change.
• Consider your future aspirations - if you have plans to buy more expensive property in the future the pension plan is more of a risk as you won't be building as much equity as repayment mortgage and you may well not be able to use any of the pension as a form of security.
• At younger ages, you have a lot of flexibility to change plans. Even if in 5 years you decide to completely change approach, you won't have over-saved into a pension by then (in terms of lifetime plans) and you can change approach to something more conventional with little or no cost in the long run.
• Using your pension fund for both retirement and mortgage will lead to very big pension funds. That leads to big volatility so you should consider how you would feel if a pension pot of, say, £500,000 lost £50,000 in a single month (which can easily happen, but can be managed by investments).
• Pension policy changes, which at first sounds bad for your plan. But, if pensions change to be less generous/attractive/flexible and interfere with your plan, in many scenarios you will have been glad you took full advantage of the incentives on offer whilst they were there.
• The Annual Allowance (£40,000 a year into pension limit from 2014/15) can limit what you might want to do.
• Prior to age 55, you are extremely vulnerable to income shocks. If you have paid off most of your mortgage and lose job/get sick, etc, you at least have low mortgage payments. If your mortgage payments have gone into your pension you still have to service a large mortgage. That again means you need a very secure asset base of more liquid assets and possibly insurance.

It is a good plan, but along with the big rewards come some pretty big drawbacks. Nothing insurmountable, but something you need to give a lot of careful thought to.

mixmastermike

Just to clarify. My current projections for retirement at my current contribution level of 27% should be ample for retirement.

If i went for an interest only mortgage then I would increase pension contributions purely to benefit from the 42% saving in tax/NI

Example:

Lets say a £250k mortgage: repayment mortgage of £1500 per month or interest only of £1150.

A difference of £350 per month or £603/month after tax/NI relief

Even with absolutely ZERO growth those contributions would add upto £217,000 over thirty years

With a conservative 3.0% growth I'd be looking at £350,000

If my investment performs well and averages 5.0% then it should add up to a cool £500k!

So yes, it's a gamble, but it could pay off hugely (unless I have missed something fundamental)

dimbo61

Please do not rely on your pension lump sum to pay off your mortgage when you reach 60/65 as you really need this money to fund your retirement.
You have a good pension so make sure you stay in it.
You need to save a deposit of 10/15% and then overpay the mortgage when you can as the sooner you pay it off the less interest you pay.
By overpaying our mortgage by £500 a month we saved £50,000 in interest and knocked 12 years off the term

mixmastermike

Thanks for the reply. I wrote my response before seeing your post. Very informative, I think the biggest drawback for me will be getting a 25% deposit, 40% seems unattainable!

My biggest concern will be the government and changes in pension rules

mixmastermike

Hi Dimbo,

Thanks for your reply. Again, I don't intend to rely on my normal pension to pay off my mortgage. I want to supplement my pension contributions by enough to pay off the mortgage when I reach retirement

Thrugelmir

mixmastermike wrote: »

If my investment performs well and averages 5.0% then it should add up to a cool £500k!

What will that buy you in 30 years time?

You'll need to increase your contributions at least in line with inflation to maintain the income.

mixmastermike

Inflation won't matter because the £250k capital borrowed will still be £250k