Will a mortgage scupper your retirement?

The figures don’t look good. In the past three years more than one million people have taken out new mortgages that will run past their state pension age.

At the end of 2023, this accounted for more than four in 10 new mortgages, with the highest increase among people in their thirties, mostly taking their first step on the housing ladder — unsurprising, when becoming a first-time buyer is the most expensive it has been for generations. But even the Financial Conduct Authority (FCA) admits that extending mortgage terms is a symptom of, rather than a solution to, today’s affordability challenge.

Conventional financial planning advises you to pay off your mortgage long before state pension age, currently at 66 (though this is set to rise). This is achievable on what were formerly considered “standard” 25-year terms. But the proliferation of 40-year terms could force homeowners to raid their pension pots to make mortgage payments, leaving them with less to live on in old age.

But is this always a mistake? 

There’s a long-running alternative strategy of never paying off your mortgage and instead investing the money that would have gone into capital payments. Those who are long-term investors — and can tolerate stock market fluctuations — may be able to earn more from their portfolios than they would pay in mortgage interest.

For younger borrowers, it might even be sensible to take out a 40-year term to maximise their disposable income in the early years, allowing them to build savings or investments, and then reduce the term when they remortgage and are earning more, or their circumstances change.

The power of compounding on investments over multiple decades means that if the money saved beats the mortgage interest paid, you could end up richer despite the longer-term debt. Typically, the best chance of achieving this is by focusing on your pension, where your investments benefit from an uplift of tax relief — and often an employer contribution to boot.

If inflation is going to be a bit higher for the next few decades compared to the last couple, having some debt leveraged against good investments will not be a bad thing

Investing can also make sense if you’re closer to retirement age and are relatively well off. James Baxter, founder of wealth management firm Tideway Wealth, was turning 62 when he fixed his mortgage for five years at 3.89 per cent. He can cover the interest cost of his £750,000 mortgage with £400,000 in Isa investments held in fixed income. 

Another benefit of longer terms is the potential for inflation to erode the debt. The average house price today is £291,000; if a 75-year-old had bought an average valued house 40 years ago, it might have cost £26,000. Had she taken a £19,500 interest-only mortgage that she’d run into retirement, she would now be paying £73 per month interest at 4.5 per cent.

Today, a 4.5 per cent mortgage cost may seem high, but with inflation at 3 per cent it’s only costing you 1.5 per cent in real terms. Baxter says: “If inflation is going to be a bit higher for the next few decades compared to the last couple, having some debt leveraged against good investments will not be a bad thing.”

For most people, it’s simply too psychologically difficult to take the risk of investments not working out.

Plus they may aspire to the pleasure of repaying a mortgage in their fifties, when financial life may be looking shakier due to changing work or health circumstances.

But there is one other benefit to having a mortgage past retirement. Noting that inheritance tax (IHT) revenues reached record levels in 2023, some wealthier people are using mortgages in retirement to reduce their liability.

We’ve reached the point where, despite main residence relief, it’s impossible to own some modest terraced houses in London and the south- east without incurring an IHT liability. Yes, married couples can pass on £1mn free of IHT, including main residence values. But the residence nil rate band tapers for estates above £2mn.

With a mortgage (or equity-release loan) to free up cash for lifetime gifts to family and friends you can live out your time in the same home without passing on a big IHT bill to beneficiaries.

Currently, older borrowers may struggle to get good terms on a remortgage. Halifax, the UK’s largest mortgage lender, last summer raised its maximum age using earned income to 75 before reining it back to 70 in March.

However, some advisers see signs of later-life mortgage rates getting more competitive, citing examples of lending up to age 80 at high street rates.

Last week Emily Shepperd, chief operating officer at the FCA, said: “Lending into retirement is moving from a niche to a norm.” According to the regulator, the proportion of mortgage customers over 67 is currently less than 2 per cent of all loans. But it predicts that by 2040 this will rise to 5 per cent, and by 2050 will be almost 10 per cent. 

Though 50-year multigenerational mortgages were in the Conservative party’s 2019 general election manifesto and haven’t yet made it into the mainstream, brokers say the market is likely to adapt to meet consumer demand, launching products which will permit later-life borrowing beyond what we currently see.

Nevertheless, lenders can withdraw from the market and lending rules can change. Some of those who took out a mortgage before 2014 found it harder to switch to a better deal because of new stricter affordability rules introduced by the FCA. So there are no guarantees and the risks of a long mortgage term may be unknown.

Moira O’Neill is a freelance money and investment writer. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’neill@ft.com