For those whose financial circumstances are suited to such products, a pension mortgage can provide a tax efficient way of clearing your debts as enter into your retirement. However, as with any form of investment, pension mortgages also come with risk, and in some cases these risks can be quite considerable.
Before weighing up the relative merits and potential pitfalls of this kind of mortgage it’s important to understand exactly how they work;
As with interest only mortgages, with a pension mortgage the amount paid to the lender on a monthly basis does not actually decrease the amount outstanding on the loan itself. Instead part is used to stop interest accruing whilst the rest goes into a personal pension, where the money (assuming all goes to plan) will build up value over time, providing adequate funds with which to pay off your mortgage when the lump sum is paid out upon the holder’s retirement, leaving enough left to provide income for the years to come.
So what’s to gain form such an arrangement? Well, pension payouts are tax free, which, depending on your level of income and tax band, could save you thousands. Furthermore, there is always a chance that the pension will outperform expectations, which could leave you with a welcome surplus of tax free cash.
Long Term Commitment
Whilst this might sound attractive you need to realistically asses whether these tax benefits are enough to justify going down this route. After all, it is, by its very nature, an even more long term commitment than the average mortgage as it will need to run until you are 50, the earliest age that you can access the funds in a pension.
Depending on your age, this could mean you have to go for a long period of time making interest payments, which could eat into any benefit you’re getting from greater tax efficiency.
Using such a product will also require that you stay committed to a personal pension plan making high levels of contributions. This could end of being to your disadvantage if later in your career you are offered access to a preferable pension scheme by an employer. Furthermore, you should remember that only 25% of the fund you build up can be taken out in your lump some payment. This effectively means you’ll need to put away at least four times the loan amount in order to avoid a shortfall.
Perhaps the biggest concern you should have when looking into this option is the possibility that your pension will under perform, forcing you into making even higher contributions, possibly at the expense of your day to day liquidity (remember the money you pay in is then inaccessible until you reach 50). Obviously, having your money tied up in this way might be problematic anyway, if you find yourself on track for lower than expected returns you have no real option but to put even more away.
Life Insurance Costs
Another potential disadvantage of having a mortgage which will run until you’re at least 50 is that, as with other mortgages, you’ll need to a life insurance policy in place to cover the debt should you die. Normally you have to go for a level term policy, the premiums for which, you will obviously be paying for a long time. This means you don’t have the option to go for a cheaper option such as decreasing term life insurance.