With lots of interest only mortgages due to end within the next 10 years, numerous consumers will discover themselves in a position where they need to pay their home loan provider back, but could have no active capital with which to do so.
They might be inclined to take their whole pension fund as a lump sum and settle their mortgage. But is this a sensible thing to do?
While everyone’s situation will be different, repaying a home mortgage in this manner might be a very costly solution. It could cost you tens of thousands of pounds in tax to do this as only the very first 25 % of your pension fund value would be paid to you tax free, so for an example if you chose to take half of your pension fund to repay your interest only mortgage then only the first quarter (25%) of this amount will be tax free, the remaining 75% would be liable to tax. This implies that you might be offering 20 % – 45 % of it back to Her Majesty’s Revenue and Customs.
For those clients with an income drawdown pension (a more versatile form of personal pension) the modifications to drawdown guidelines prepared for April 2015 might help clients manage their finances in a different method than originally envisaged.
It would be an excellent idea to pay off your home loan with just the tax free element of your pension fund, if your pension fund was sufficiently large for you to do this. Therefore if your mortgage debt is £50,000, you would ideally need a pension fund of £200,000, which would then enable you to take the £50,000 you require to repay the mortgage totally tax free. Regrettably, in our experience the average pension fund in the UK is worth between £ 40,000 – £ 100,000.
Even if you choose to pay the tax and make use of all your fund to repay the mortgage, exactly what are you going to survive on in retirement? While you have to consider how you will pay back the home loan, it is equally crucial that you consider how you are going to live in retirement if you have no money.
Our view is that you must create a plan prior to your requirement that includes the need to repay the home loan. You need to consider alternative products such as an equity release mortgage; your other financial circumstances along with any other action you could take. Can you pay towards a repayment home loan now?, Even if you can’t – all interest only mortgage loan providers will permit you to make overpayments, which immediately comes off the balance of the mortgage.
Establishing a routine overpayment will slowly have a longer term monetary advantage. As the general loan reduces, then the amount of interest you have to pay each month also reduces. This demonstrates that some of the cash that you were using to pay the interest now goes in the direction of repaying the debt. Gradually as each month passes more of your original payment plus the over-payment goes towards lowering the debt.
It is also worth considering your household and home and what you desire to happen to it after you are gone. If you die having repaid your home loan, then your house will pass to your youngsters and estate. If you have a mortgage debt, including an equity release loan, then that will certainly have to be repaid first and any money left after this will then be passed on. However if you are going to use all of your pension fund to pay back the home loan you could be compromising your quality of life as you get older to leave an inheritance for your estate and family.