03 August 2019

'RIO' home loans "not the answer" for majority of interest-only borrowers - Royal London Analysis

4 min read

 
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Becky O'Connor

Personal Finance Specialist

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The majority of interest-only borrowers hoping for a ‘RIO’ (retirement interest-only) 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.

Hundreds of thousands of interest-only borrowers will come to the end of their loans over the next few years with no obvious way of paying off the capital balance. They may have hoped that a new interest-only mortgage running through retirement would be the answer.

But with official figures showing that around 12 million people are not saving enough even to cover basic living costs after they retire, very few 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.

Royal London has estimated that someone on average earnings who wants to maintain their standard of living into retirement needs a pension pot of around £260,000[1]. But this assumes that they will have paid off their mortgage.  If they need to take out a mortgage for £121,000[2] to clear their interest-only debt, the mutual insurer calculates they will need an extra £118,256 in their pension pot to service this debt for as long as they live.

Whereas the affordability test for a standard working-age mortgage relies heavily on the income of the highest earner or joint earnings, in retirement the lender has to 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 can seem affordable when both partners are still alive can become unaffordable if one dies.

Royal London is encouraging couples to find out what will happen to their pension income when one partner dies so that they have a realistic idea of how affordable an in-retirement mortgage would be.

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.

“Generally speaking, 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.”

“So even those who have a ‘decent’ pot size of £260,000 might find they wouldn’t have enough income in retirement to pay RIO mortgage repayments and still maintain a decent standard of living.

“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.”

“It’s likely that uptake of RIOs will therefore be reserved for those endowed with the most generous pensions, or income from other sources such as property or work.”

According to the FCA, around 10 per cent of interest-only loans are not backed up with any repayment plan, while 50 per cent 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 1.66mn, according to UK Finance.

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 retirement interest-only loan in order to avoid repossession.

For further information please contact:

Becky O’Connor, Personal Finance Specialist

Notes to Editors

[1] Target pension pot from Pg 8 “Will we ever summit the pensions mountain?” https://www.royallondon.com/siteassets/site-docs/media-centre/policy-papers/will-we-ever-summit-the-pensions-mountain.pdf

 

[2] FCA findings of review into interest-only mortgages, 2013 https://www.fca.org.uk/news/press-releases/fca-publishes-findings-review-interest-only-mortgages-and-reaches-agreement

 

Average balance of an interest-only loan without an endowment plan is £121,000 (FCA). Typical interest rate on a RIO loan = 3.99% (RL research). Best rate for an annuity for a 65-yr old is currently £4,939 a year per £100,000 (Hargreaves Lansdown). Additional pension pot required is £118,256.

About Royal London:

Royal London is the largest mutual life, pensions and investment company in the UK, with funds under management of £130 billion, 8.8 million policies in force and 4,046 employees. Figures quoted are as at June 2019.