Older borrowers could continue paying their mortgages until they die or move into care, under a new proposal by the city watchdog.
The Financial Conduct Authority (FCA) has launched a consultation to consider introducing retirement interest-only loans. These mortgages would see borrowers paying the interest on their mortgages without repaying the loan, and would last until death or a move into a care home.
Which? looks at how retirement interest-only loans would work and the pros and cons of these arrangements.
What is a retirement interest-only loan?
Under an interest-only deal, borrowers pay the interest due on their mortgage, but do not make regular repayments on the loan itself. Over the years, the balance you owe doesn’t decrease.
The FCA is proposing to allow older borrowers to take out interest-only loans, which they would continue to pay until they moved into a care home or died. At that point, the bank would sell the house to repay the loan.
The owner – or their estate – would benefit from any value growth in the property, and the initial deposit.
Find out more: Interest-only mortgages and repayment mortgages – how these products compare
How a retirement interest-only loan would work
While repayments are significantly lower on an interest-only loan, a borrower will ultimately end up paying more interest over time without increasing their share of ownership. But if the property grows in value while you own it, you could still stand to make money on an interest-only deal.
Example of interest-only versus repayment mortgage
Say you buy a property at 55 years old for £250,000 with a 20% deposit – meaning you borrow £200,000. Let’s assume your interest rate is around 1.8% over the whole of your mortgage.
You’re lucky – the property grows in value by 5% per year. After 20 years, when you move into a care home, the property is worth around £670,000.
How much money would you have left in your pocket?
In the above example, it’s tempting to think that the interest only investor ends up better off because they save £693 a month in mortgage payments – but that isn’t the case.
When both parties go to sell, the capital-repayment borrower will keep £670,000 (leaving aside any sale costs). But the interest-only borrower only pockets £470,000, as they need to repay the original £200,000 loan to the bank. The interest-only borrower saves £166,320 in mortgage payments – but the cost of clearing the mortgage at the end means they are £34,680 worse off.
This example also assumes your property will grow in value, which it’s not guaranteed to do. If your property price stagnates, an interest only borrower may walk away with much less – and if were to drop, you or your estate could end up owing the bank money after the sale.
Also, older borrowers are unlikely to qualify for a repayment mortgage that will last beyond their working years – so in our example, the reality is a borrower today might have few options for getting on the property ladder at all.
Find out more: How much can you borrow? – find out how much your money will get you
Why is the FCA proposing the change?
Currently, few interest-only loans are available in Britain – and borrowers looking to take one out need to show evidence of a plan to repay their loan. Yet more than 1.9 million borrowers remain on interest-only loans today from deals agreed in the 2000s, when they were more readily available.
While the majority of people on interest-only arrangements have a plan to repay, many don’t. When their term runs out, these homeowners must try to remortage or face losing their homes.
But in order to successfully remortgage, home owners need to show they can afford the payments on the new deal – which might be significantly higher. Older homeowners may also be ineligible for a repayment mortgage, as they’re unlikely to be working long enough to pay it down.
The FCA is hoping a retirement interest-only proposal could be the answer for these homeowners. The lower payments means they need a lower income to qualify, while allowing the deal to extend to retirement could help older borrowers.
At the same time, there is some concern that paying off an interest-only mortgage is effectively the same as renting – especially if your property doesn’t grow in value.
Find out more: Interest-only mortgage crunch: how to pay one down
Alternative to lifetime mortgage
A retirement interest-only mortgage could also be an option for older people hoping to release equity from their homes. Currently, one of the main options is a lifetime mortgage, where a new mortgage is placed over the property and interest payments are ‘rolled up’ into the loan.
When the owner dies or moves into care, both the loan and interest are repaid from the sale of the house. But lifetime mortgages have high interest rates that can quickly eat up any equity in a home, leaving very little for the person’s care needs or heirs.
The FCA currently classifies retirement interest-only mortgages as a type of lifetime mortgage. Their proposal would see the two concepts separated out, with different lending criteria applied.
This would allow oder borrowers who can afford a small monthly interest payment to remortgage, releasing equity for their retirement.
Find out more: Lifetime mortgages – the pros and cons
Have your say on interest-only retirement mortgages
The FCA is currently seeking input on the community’s views about its proposals – the full FCA report is available online. The consultation is open until 1 November and submissions can be made in writing by any organisation or member of the public.
*EDITOR’S NOTE: This story has been edited to clarify the financial comparison between interest only and repayment mortgages.