Later Life Mortgages – the Options

What is the difference between equity release, Retirement Interest Only (RIO), home reversion, and a standard mortgage?

As you approach retirement, securing a mortgage can be more challenging. Later life lending applies if you will be at retirement age before your mortgage term ends. So, if your mortgage term is 35 years you may find yourself in the ‘later life lending’ category at the age of 36!

Some lenders may be cautious about offering you a mortgage that extends into retirement. However, there are many options that are tailored to meet the needs of older borrowers, whether nearing, or already in retirement. Some mortgage lenders may also have more flexible lending criteria than others.

Whichever option you go for, it’s essential to understand the long-term implications. These include:

• Interest rates
• Repayment types
• The impact on your estate
• Your options in the future
• Any means-tested benefits

It’s best to do some thorough financial planning to decide what’s right for you. You may wish to consider seeking the help of an independent financial adviser who specialises in later life planning.

What age is retirement?

Some people might access their private or workplace pension from 55. O thers will draw their state pension in their late sixties. Some may plan to work into their seventies.

Most lenders will take your steer on when you plan to retire, however they will each have their own guidance around what income they will use. To give you an idea, we can consider employed or self employed income up to age 70 for manual jobs, and 75 for non-manual jobs. Beyond this we ensure the mortgage remains affordable based on your anticipated retirement income. This could be from state or private pensions, as well as things like investments or property income.

Standard mortgages

Standard repayment mortgages

A repayment mortgage is sometimes known as a capital and interest repayment mortgage as your monthly payments will cover the interest due, plus a portion of the capital borrowed. This is generally considered the lowest risk mortgage type, as it provides security that at the end of the mortgage term your mortgage will be repaid in full, (if all payments have been made in full and on time).

Some lenders will offer their whole range of standard repayment mortgages to older borrowers, however many will only lend up to a certain age, typically 75. As we have no maximum age cap, this allows older borrowers more options to consider a repayment mortgage where they may not otherwise be able to.

Standard interest only mortgages

An interest only mortgage is often an option from lenders for borrowers in this age category. It means that borrowers only pay the interest accrued each month. This makes your monthly payments lower, but the mortgage balance doesn’t reduce. At the end of the mortgage term, you’ll need to repay the full amount you borrowed. However, because you’re making monthly payments to cover the interest accrued, the total amount owed at the end of the mortgage term won’t be more than you initially borrowed (if all payments are made in full and on time, and apart from any fees added).

There needs to be a repayment strategy in place to repay the mortgage amount at the end of the term. This could involve downsizing by selling the property and moving to something smaller. Or maybe there are investments or a pension which could pay off the amount owed.

Standard part and part mortgage

This option is a combination of the Standard repayment and Standard interest only mortgages highlighted above. Part of the money borrowed is taken on a repayment basis, with the other part on an interest only basis. This will mean your repayments are lower than if you had taken a mortgage on a full repayment basis. It also provides a guarantee that part of the balance will be repaid by the end of the mortgage term (if all payments are made in full and on time).

You will need to have a repayment strategy in place to clear the interest only portion at the end of the mortgage term.

This option can be useful if you have a repayment strategy that only covers part of the amount you want to borrow. E.g. you are borrowing £100,000 and have a repayment strategy that will clear £60,000 at the end of the mortgage term. You could have £60,000 on an interest only basis, and £40,000 on a repayment basis.

Retirement Interest Only (RIO)

Nothing to do with a city in South America, a RIO is a Retirement Interest Only mortgage. This is not to be confused with a standard interest only mortgage (see above) as it’s only available for older borrowers.

Rather than the loan needing to be repaid at the end of an agreed term the loan is not repaid until a significant life event. This could be:

• Selling the home
• The death of the last remaining borrower
• When the last remaining borrower goes into long-term care.

Typically you must be over 55 years of age and there are fewer lenders which offer RIO mortgages than other types of mortgages.

Interest only and part interest only – things to bear in mind

These will apply if you have either a RIO, a standard interest only mortgage, or a standard part and part mortgage.

Interest only mortgages can be an attractive option. As with any mortgage, you need to make sure it’s the best option for you and your circumstances.

Benefits

• Lower monthly payments than a repayment mortgage – this can free up cash for other expenses.
• Flexibility – some borrowers use the savings from lower payments to invest elsewhere, or to help with enjoying retirement, from hobbies to holidays.
  

Downsides

• The debt remains – since you’re not paying down the mortgage balance, you’ll still owe the full amount at the end of the term. This will be a lower amount if you’ve been paying part and part, (you will know what this amount will be before you take out the mortgage).
• Repayment risk – unless you take a RIO mortgage, you’ll need a solid plan to repay the mortgage (or interest only element for part and part) whether through savings, investments, or selling your property. There is no guarantee that your strategy will clear the balance as intended.
• Higher interest rates – rates are often higher for interest only or part interest only mortgages compared to repayment mortgages.
• Higher costs in the long run – over the full term of the mortgage the interest paid will be substantially more than what you would have paid on a traditional repayment mortgage.
• Potential for negative equity – if property prices fall, you could end up owing more than your home is worth. The risk of this is reduced slightly with a part and part mortgage, as you’re reducing part of the balance with every monthly payment made.

Repayment mortgage – things to bear in mind

Repaying all or some of your original loan can be a good option for many people. As with any mortgage, you need to make sure it’s the best option for you and your circumstances.

Benefits

• You’ll have the certainty of repaying the money borrowed. You won’t have to have a plan in place – also known as a repayment strategy – in order to repay the balance at the end of the term.
• Lower interest rates – rates are often lower for repayment mortgages compared to interest only or part and part mortgages.
• Lower costs in the long run – over the full term of the mortgage the interest paid will be substantially less than what you would have paid on an interest only or part interest only mortgage
• There’s less potential for negative equity – if property prices fall, you could end up owing more than your home is worth. Because you’re reducing the balance with every monthly payment, the risk of this is less than with an interest only mortgage.

Downsides

• You’ll have higher monthly payments than with an interest only mortgage. You’ll therefore have less to invest elsewhere, enjoy retirement with, or spend on hobbies and holidays.
• In the early years the majority of the monthly payment will be covering the interest due. (However, as the term progresses, more and more of each payment made will be reducing the mortgage balance.)

Equity Release mortgages

Like with a standard mortgage, with an equity release mortgage you can usually raise funds for things such as home improvements, or repaying an existing mortgage. However, equity release can assist with raising funds for additional areas such as general living costs, or lifestyle costs such as holidays.

With an equity release mortgage no monthly payments are due, this means that when applying for an equity release scheme no affordability assessments are required. This is particularly useful if the funds being raised are to help with general living costs. However, if you choose not to pay the interest due, this will be added to the balance you owe, which will grow over time. The interest added will be ‘compounded’ , this means that you will be paying interest on the interest already accrued. Therefore by the time the mortgage is due to be repaid, the balance can be substantially higher than the amount you borrowed. While many providers will offer a no negative equity guarantee, this means you may have little to nothing to pass on when you die.

There are two types of equity release schemes:

Lifetime mortgages. A lifetime mortgage in principle is very similar to a standard mortgage, as you retain 100% ownership of your home. You’ll receive a cash lump sum, or multiple sums, as a form of equity release (or a lump sum to repay an existing mortgage balance). The funds are secured against your home and the loan is then repaid from the sale of your property. Unlike a standard mortgage with a set term, like a RIO mortgage , repayment will only be due after you die or move into long-term care. Typically, you have to be over 55 to have a lifetime mortgage.

Home reversion plans. A home reversion plan is where you sell all, or part of the value of your home, to your mortgage provider – usually between 25% and 100%. This gives you a tax-free lump sum whilst allowing you to stay in your property as a tenant. If you are older, or in poor health, you may get a higher payment than those who start the scheme from a younger age. Like with a RIO or lifetime mortgage the plan ends when you die or go into long-term care. However at this point your provider will take ownership of the portion of your home that you’ve sold. The remaining portion is paid to you or your heirs, minus the amount that is owed. Typically, you have to be over 60 to take a home reversion plan.

Is a later life mortgage the same as an equity release scheme?

No. There are vast differences between standard residential mortgages and equity release mortgages. These differences include:

• Standard residential mortgage interest rates are typically lower than equity release rates. Over the term of the scheme this can mean a difference of thousands of pounds in the overall cost.
• A later life mortgage is an agreement for a selected term. You can choose how long a time period you wish to borrow the money for. RIO and equity release mortgages don’t have a set term, instead they end with a significant life event, such as when you go into long-term care, or you pass away.
• Later life mortgages generally have a product that only runs for part of the overall term. This means you may be able to remortgage to switch between later life mortgage deals and providers. Most equity release schemes have an interest rate that is fixed for the term of the mortgage. Depending on the performance of the mortgage market, these different types of product tie in can have their own pros and cons.
• With a standard later life mortgage, if you come into a lump sum or an inheritance, you could make overpayments or repay your loan (subject to the terms of the mortgage). While most equity release schemes will allow overpayments the terms can be more restrictive. Especially when it comes to home reversion schemes, some of which may not allow any overpayments at all.
• Later life borrowers can choose to make interest only or capital and interest repayments. This means that the interest doesn’t compound or ‘roll up’ as it can do with equity release. Some lifetime mortgage schemes will allow regular monthly interest payments, or overpayments. However, the restrictions can be greater than with a standard mortgage. Many home reversion schemes may not allow overpayments at all.
• Most lifetime mortgages offer the option to ‘port’ the scheme to a new home. As with a standard mortgage the borrower and new property would need to meet the lending criteria of the lender at the time of the move. However most home reversion plans will not provide the option to move home and retain the existing scheme. Instead, you would need to buy back the % share you had sold to the scheme provider at the current market value, which is often much higher than the amount of funds leant to you.

In summary, the mortgage market has moved on since the rigid age caps of decades ago and you may find that a standard residential mortgage is better suited to your needs. Or you may prefer to go down the RIO or equity release route.

You may wish to get the help of an independent financial advisor to help with your decision.

Taking on a mortgage at any age is a big financial commitment. We suggest that you consider gaining independent advice before deciding whether to proceed with a mortgage. The following organisations can offer impartial advice.

Age UK – 0800 055 6112
Equity Release Council – 0300 012 0239
Pension Wise – 0800 138 3944
Citizens Advice – 0345 404 0506
Money Helper – 0800 011 3797
HM Revenue & Customs – 0300 200 3300

You might also be interested in our Guide to Downsizing Your Home, where you can find information on everything from the financial considerations involved, to how to approach the topic of downsizing with family.