Borrowers could face pressure to use pension cash

Borrowers may come under pressure to use retirement savings to clear mortgage debt when new pension freedoms come into force next year, consumer campaigners have warned.

The practice of using the tax-free portion of a pension pot to pay off a home loan has long been commonplace among homeowners, particularly sophisticated investors.

But as of April, it will be much simpler to use all pension savings to clear outstanding debts when reforms come into force allowing those aged 55 and over to cash in their retirement pots.

Campaigners fear that lenders will seize on the new freedoms to suggest customers use their pension savings to cover shortfalls, particularly in interest-only mortgages.

According to the Council of Mortgage Lenders, there are about 3.8m outstanding interest-only mortgages granted to UK homeowners. About 600,000 borrowers are expected to see their loans mature by 2020, according to the Financial Conduct Authority, with a third expected to face shortfalls of more than £50,000.

“Under the old pension rules, banks could not insist pension pots be used to repay a mortgage, as aside from tax-free cash, it was not possible for most to turn their savings into a lump sum,” said Dominic Lindley, an independent consumer campaigner.

“But the new flexibility to take pensions as cash could see this used as one of the ways to repay a mortgage.”

If an interest-only borrower faces a shortfall when their mortgage matures, the lender and the mortgage customer can enter into discussions about ways to deal with the debt, including converting the mortgage into a repayment loan.

However, tighter lending conditions brought in under the mortgage market review in April may prompt more use of pensions cash, since the remortgage options available to over-60s have dwindled since the financial crisis.

Those with interest-only mortgages taken out before the crisis may find themselves unable to remortgage on similar terms and unable to afford the higher monthly payments associated with a repayment mortgage.

“There is a risk that banks could not offer forbearance to these customers,” said Mr Lindley. “A lot will depend on the attitude of the banks but there is a risk that they will view pension savings as one of the ways the borrower could repay their debt.”

After prompting by regulators, lenders have contacted at-risk interest-only borrowers – those whose loans mature before 2020 – to ensure they have a plan to repay the balance of their loans.

However, Ray Boulger, technical director at mortgage broker John Charcol, said lenders would be unlikely to suggest the use of a pension pot to pay off a mortgage.

“Lenders won’t want to get into the area of giving pensions advice,” he said. “There are too many regulatory risks involved.”

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Advisers said using pension funds to clear a mortgage debt was not a clear cut decision as factors, such as the income tax payable on pension savings accessed flexibly, needed to be weighed up.

“Tax and investment implications mean it’s not a simple decision, so it’s vital that people do their research or take advice before acting,” said Stephen Berry, financial planning technical analyst with NFU Mutual, a financial services provider.

However, he added: “You don’t have to retire to use your pension so people still in work can consider this option. With the mortgage paid off, the extra disposable income could be even be invested back into a pension to take advantage of the tax breaks.”

Under the reforms, pension savers will continue to have access to a quarter of their pension pot tax-free, with the remainder subject to income tax.

From April, those who carry on paying into a pension after accessing some of their savings flexibility will see their annual allowance fall from £40,000 to £10,000.

You don’t have to retire to use your pension so people still in work can consider this option

The introduction of the new freedoms may coincide broadly with the first rise in interest rates for over five years. If the Bank of England raises rates, as it has hinted it will start to do within months, more people will struggle to make their monthly mortgage repayments.

The Resolution Foundation think-tank has calculated that one in four households would face repayment problems if rates rose in steps to moderate levels by 2018. More than a million would find themselves in so-called “debt peril”, where more than half their income goes on mortgage payments – up from 600,000 now.

Particularly at risk are those on interest-only mortgages. “Many of them don’t have a ready repayment mechanism in place,” said Brian Murphy, head of lending at broker Mortgage Advice Bureau.