The worrying rise of 40-year mortgages

The cost of these long-term loans may be the prospect of retirement – or a much bigger pension, warns interactive investor.

This week saw the launch of another 40-year mortgage product.

The number of mortgages with 40-year terms available is 146, according to Moneyfacts. Most come with maximum ages of 75 – seven years after someone currently in their mid-thirties is likely to start receiving the state pension and 12 years beyond the average healthy life expectancy in the UK, according to the ONS*.

Interactive investor is warning homeowners, including first-time buyers in their mid-thirties who are considering long mortgage terms, to seriously consider the implications for their retirement plans.

They might have to contribute significantly more into their pensions to cover their mortgage repayments after they retire, or be prepared to work for longer. However, ill health and other life events often prevent people being able to work for longer, even if that is their intention. This could put those with mortgages in later life at risk of not being able to continue to meet their repayments in old age.

Respondents to the interactive investor Great British Retirement Survey had an average age of 60, with an average of 11 years remaining on the mortgage. This suggests that when some retire, they will still have some form of mortgage: 12% of respondents said they were worried they may never pay it off.

Typically, ‘what you need’ retirement income scenarios assume that all housing costs are paid off. The rise of the 40-year mortgage, as well as a long-term increase in the number of people renting privately, means that an increasing number of retirees will have housing costs when they retire. For these individuals, the amount needed in their pension to cover living and housing costs could be far higher than the assumptions they are currently working towards.

If they can’t meet this extra budget for housing costs through additional contributions to workplace pensions or through working into old age, they might end up exhausting any private pension provision built up far sooner. They would then be dependent on the state pension in their later retirement years.

According to calculations by interactive investor, a 30-year old currently earning £27,500 is on track for a pension pot worth approximately £190,000 if they pay 8% of their salary into a workplace scheme until they are 68. The PLSA estimates that £20,800 a year is enough for a moderate retirement income, including the state pension.

Interactive investor calculates that based on average yearly mortgage repayments of £7,644**, someone who has a mortgage to 75 would need private pension savings to deliver an income of £19,105, on top of their state pension, to age 75, to cover their living costs and mortgage. The pot worth £190,000 would run out at age 75 if it had to cover this full amount, leaving that person dependent on the state pension alone from that age. Without mortgage costs to 75, the pot would last until 79, at the PLSA moderate level of income.

This may already be an issue facing a small proportion of current retirees. The Great British Retirement Survey from interactive investor found that 9% of retired people are still paying off a mortgage, while 1.5% are renting privately. Of those with a mortgage, 40% are on capital repayment loans and 48% have interest only mortgages.

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “The rise of mortgages with ultra-long terms that stretch way past retirement age is worrying. It requires a fundamental rethink of what people will need in retirement and could require a change to the assumptions that underpin current guidance for pension savers on how much they should aim to have in their pot.

If you are considering paying a mortgage into retirement, there’s a huge reality check coming: you will need a much bigger pension than most people are currently on track for to finance this additional borrowing.

“Generally, mortgage brokers don’t interrogate people on their retirement plans, asking only at what age someone plans to retire as part of the application process. It’s very hard for both borrowers and brokers to know at what age they will end up retiring though, and whether they will have enough pension to cover repayments, if they have to give up work earlier than they initially thought when they were applying for the loan. It’s hard to project this far into the future when you are in your thirties and you may have an optimistic view of what you will be capable of, work-wise, when you are 70. The difficulty is being able to guarantee the ability to continue working until 75, even if that is someone’s intention four decades earlier.

“When the auto-enrolment minimum was set it really was a minimum and assumes that it will provide enough in retirement for the average earner, who also receives a full state pension and doesn’t have any housing costs when they retire. Unfortunately, the development of longer-term mortgages and the rise of private renting call these assumptions into serious question. If people have housing costs when they retire, they will either need a bigger pension or be able to work for longer – or face running out of money sooner.”

Notes to editors:

• Data provided by Moneyfacts to interactive investor correct as at November 22 2021.
• *ONS Health state life expectancies
• PLSA moderate income estimate
• ** English Housing Survey page 19 2.7