Pension freedoms make it harder for over-55s to get a mortgage: Former pensions minister warns lenders must address this worrying ‘mismatch’
Thousands of UK retirees face difficulties getting a home loan due to a downside of new pension freedoms, one of the chief architects of pension reforms has warned.
Speaking at the Building Societies Association’s annual conference, former pensions minister Steve Webb warned that flexible access to pension savings had a ‘worrying’ downside for those who need a mortgage after they retire.
His comments put renewed pressure on mortgage lenders to relax rules for retired borrowers to ensure they don’t become unstuck as an unintended consequence of the pension changes.
Steve Webb, director of policy at insurer Royal London, is concerned by how many people may not be able to get a mortgage after they retire if they use the pension freedoms
He said: ‘Although I was one of the architects of pension freedoms, which allowed you to take your pension savings and do what you want with it, the downside of that is, of course, that it isn’t a guaranteed income for life if you don’t buy an annuity.
‘There is now more of a mismatch between the way people are organising their wealth in retirement and a mortgage – something you have to pay on an ongoing basis.’
Pension freedoms were introduced under the former Conservative government in 2015, and allow those over the age of 55 much more flexibility in how they access their savings.
Over 55s can now draw some of or their entire pension savings out of a defined contribution pension, instead of simply buying an annuity as most did in the past.
There are various ways this can be done, most of which result in a variable income in retirement.
The introduction of pension freedoms has helped to prompt a sharp move away from annuities, which offer a guaranteed income for life but have been seen as inflexible and expensive in recent times. However despite their disadvantages, annuities offered greater certainty for mortgage lenders, which has been compromised as retirees increasingly reject them.
Pension freedoms might offer increased flexibility for retirees, who like the freedom of being able to choose how they use their savings, but mortgage lenders take a dim view of income that isn’t ‘guaranteed’.
This is because of rules introduced in 2014 that mean lenders must assess whether a borrower can ‘afford’ the repayments on their mortgage. This assessment looks at income and expenses on a monthly basis.
Where income might be lower one month but higher the next, nearly all mortgage lenders refuse to consider the higher amount.
Instead, many will take either the average income over a year, the lowest monthly income or allow for a percentage – around 50 per cent usually – of the variable annual income to be considered for the purposes of getting a mortgage.
The net result is that those with a variable income find they can borrow far less than those with a guaranteed income in retirement from either a final salary pension or annuity – depending on its size.
Webb warned that while this is already an issue for homeowners making use of the pension freedoms, it’s likely to get a lot worse in the next 10 years.
He said: ‘At first glance, why should we give a damn? Just because you’re over pension age and still have a mortgage, so what?
‘Actually, I’m far more worried about someone under pension age who has an income that might go tomorrow than someone over pension age whose state pension is effectively guaranteed and might have a final salary pension which is also guaranteed.
‘Is there a problem? In the past one might have said no. But if we move into a world where people’s pension incomes are much lower and much less certain, we might be more worried in the future.’
Why is it hard to get a mortgage after you retire?
DB pensions – or defined benefit – are another name for final salary pensions which were the dominant workplace pension for decades.
However, over the past 20 years nearly every DB pension scheme has closed to new members, with companies now offering DC, or defined contribution, options to employees instead.
These tend to have much lower contributions from employers, meaning those with this sort of deal end up with less income in retirement.
‘At the moment we’re still in living in a sort of false consciousness – we’re living off the legacy of final salary pensions,’ said Webb.
‘We’re now at DB peak. People retiring now are probably going to get the biggest final salary pensions of anybody before or since. And with every passing year, more and more people are going to have less guaranteed income in final salary and more defined contribution income pots, which fit less well [with mortgages].’
BSA chief executive Robin Fieth launched the research earlier this month
Research published by the Building Societies Association and the International Longevity Centre earlier this month highlighted just how big the scale of this future problem is.
It suggests that among those aged between 55 and 59 today, 11 per cent – 400,000 people – will have an outstanding mortgage balance when they reach 65.
Those retiring with a mortgage aged between 60 and 64 today face an average outstanding debt of around £85,000.
The research estimates that approximately 6.4 per cent (or 1.42 million) of all people aged 35 to 64 will not have paid off their mortgage by retirement given the current term of their loan.
On average, future borrowers in retirement aged 35 to 64 have 17.8 years left to pay off their mortgage, while those aged 60 to 64 have 10.8 years left.
Webb said: ‘Hoping people will use their pension pots to pay off outstanding mortgage debt would be lovely – if they had pension pots.
‘One of the problems that we have is we’re moving from a world of final salary pension pots to a world where the typical value of a pension pot used to buy an annuity is of the order of just £30,000.’
What could lenders do to help?
There is broad recognition among mortgage lenders that this is a big problem and there are multiple ‘working groups’ trying to find a solution.
Tighter rules introduced in 2014 to force mortgage lenders to require proof that borrowers can afford to repay their mortgage made it much harder for swathes of older homeowners to remortgage.
Lenders also imposed maximum age limits on those they’d lend to, with many lenders refusing to give mortgages to those who would be older than 65 by the time they expected to repay their mortgage.
Over the past year building societies in particular have tried to address this side of the problem and there are now 34 building societies that will consider mortgage applications from individuals who will be 80 or older by the time they pay off their loan.
This doesn’t help those using the pension freedoms though. The rules set down by the Financial Conduct Authority in 2014 do actually allow lenders to lend to people after they retire – but a lot of banks and building societies are nervous about ‘stretching’ their interpretation of them.
There is still a lot of reluctance to engage with what the watchdog might see as ‘risky’ lending in the aftermath of the financial crisis.
Prudential Regulation Authority rules make it very expensive for lenders to offer lifetime mortgages to borrowers
However, last year the FCA tweaked one rule so that borrowers who plan to pay interest monthly for a while and then switch their loan into a lifetime mortgage – equity release – don’t have to pass such strict income assessments.
Hardly any lenders want to offer mortgages like this though – Hodge Lifetime is the only major player with a product it actively markets.
And this is where the problem lies. Lenders are also governed by the Prudential Regulation Authority – and this regulator requires lenders to hold significantly more capital for lifetime mortgages.
In short – it’s basically far too expensive for normal banks and building societies to lend to into retirement on a loan that can convert to a lifetime mortgage.
If one thing could provide a shot in the arm for homeowners who need a mortgage after they retire and don’t have a final salary pension, relaxing this particular rule is it.
Do you need to remortgage after you retire?
Think about where your income is coming from and whether you need some of it to be in a guaranteed format – such as an annuity.
It is also worth speaking to an independent financial adviser who can advise you on your pension, investments and your mortgage, as well as equity release.
If possible – get this advice before you retire – it pays to be as prepared as you can.
The government also offers a first step through Pension Wise, to help you understand the pension freedoms and what your options are – but they won’t advise you what the best option for you is going to be and they’re unlikely to be able to help you with your mortgage. They focus on pensions.
Last month Michelle Cracknell, chief executive of The Pensions Advisory Service which runs Pension Wise’s telephone guidance sessions, said the pension industry had a duty to work much more closely with the property industry to reflect the growing number of people reliant on their property to supplement their retirement income.
Webb has also called for a review of the role that Pension Wise plays in light of the changing situation for many people.
He said: ‘We might want to think about the advice framework at and around retirement – yes you might want to take your wealth at retirement and do what you want with it, but if lots more people have a mortgage to service as well, what’s the right way to take that wealth?
‘That, I think, is a conversation that financial advisers are barely having at the moment.’