Retired homeowners looking to convert their home equity into cash have in the past had limited options.
Traditionally, the route to do this was through equity release, usually through a lifetime mortgage – but these are often expensive, and can eat into a borrower’s remaining home equity, limiting what they leave behind in inheritance.
But now there is an alternative. Vernon Building Society has launched an offset retirement interest-only mortgage – allowing borrowers to offset part of their loan against their mortgage, and only pay interest on the difference.
The portion of the loan not taken straight away is held in an instant access account – meaning the homeowner can draw upon it at any point. But is this deal as innovative as it sounds, and are there any better options already out there? We take a look…
The deal allows retired borrowers to take a portion of their loan up front and the rest later
How does it work?
Put simply, a retirement interest-only mortgage is like a standard interest-only remortgage that can be taken into retirement, and which can be paid back once the home is sold, the homeowner dies or goes into full-time care.
They’re generally only available to over-55s, but unlike some equity release products the interest is paid off monthly, so it doesn’t roll up and eat into the equity the homeowner already holds.
When applying, homeowners don’t have to prove they have a credible repayment plan in place, as they would with traditional interest only-deals, instead only having to prove they can keep up with the monthly repayments.
Vernon’s new deal allows retirement interest-only borrowers to effectively reduce their borrowing if they hold funds in an offset savings account with the Society.
Offset mortgages link your savings to your mortgage. Instead of earning interest on your savings, the money in the savings account is offset against your loan balance, and you pay interest on the difference.
What do mortgage brokers think?
David Hollingworth, of mortgage broker London and Country, said: ‘Offset is not a new concept in the mortgage market but should have some clear benefits for older borrowers considering retirement interest-only.
‘Those that want to take out some of the equity in their home but don’t need a lump sum to use all at once can offset any excess funds, That will help keep the mortgage interest charge to a minimum but still leaves the cash easily accessible in a savings account, so it can be drawn upon as and when required.
‘If there’s a downside then the rates are not the lowest in the market and offset is currently available on a 3 year discounted variable basis, so offsetting and fixing the rate is not an option.
‘However for the right borrower who will make good use of the functionality it could be a great fit.’
For example, if a borrower takes a £50,000 mortgage, but only wants to access £20,000 of that money immediately, they can put the remaining £30,000 into their offset savings account where it will be offset against their mortgage, meaning interest would only be incurred on the £20,000 balance.
The offset savings account is set up on an instant-access basis, so the borrower can withdraw money as and when they need to.
As they spend money from their offset savings account the amount offset against their mortgage will reduce, therefore an increased loan balance will then incur interest.
The borrower can add any of their own savings to their offset account, further lowering the amount of interest they have to pay.
There are two deals on offer. The cheaper option is a three-year discounted variable rate at a 1.71 discount to the lender’s 5.2 per cent standard variable rate. This puts the initial rate currently at 3.49 per cent.
It comes with a fee of £499 and a 3 per cent early repayment charge for the first two years, falling to 2 per cent in year three.
This deal is available to homeowners with a lasting power of attorney in place.
If the homeowner doesn’t they are offered the same deal, except with the discount to SVR set at 1.21 per cent, making the initial rate 3.99 per cent.
Vernon’s SVR can change, so the initial three year deal isn’t fixed for the three year period. After the three years are over, the borrower will start paying the 5.2 per cent SVR.
Both these deals are available up to a maximum loan-to-value of 50 per cent.
The mortgage is underwritten and assessed for affordability based upon the full amount applied for at outset, and the minimum loan size is £25,000.
Who is this deal for?
Retirement interest-only mortgages were originally introduced by the financial watchdog as a way for lenders to help retired ‘mortgage prisoners’ – homeowners stuck on interest-only mortgages that are set to mature with no repayment plan in place.
A retirement-interest only mortgage has no maturation date and instead is paid back once the homeowner dies or goes into care – allowing homeowners to remortgage from existing deals without worrying about how they will have to pay the loan back.
Vernon’s new deal is probably not the right fit for these borrowers, who would likely be better served with a cheaper, standard retirement interest-only deal.
However, this deal could be useful for cash-poor pensioners. Years of low interest rates, poor annuity returns and rising inflation have had a real impact on the cost of living for those relying on pensions, savings or fixed retirement incomes.
This demographic could potentially benefit from using some of the wealth tied up in their property to supplement their income.
And as the funds are held in an offset account until they are drawn upon, this results in lower monthly repayments initially.
How does it compare?
There are already drawdown lifetime mortgage options that offer similar facilities.
Last year Saga launched the Regular Drawdown Lifetime Mortgage, an equity release deal which allows homeowners aged over 60 take a pre-agreed level of equity out of their home each month as cash.
However, as there is no monthly repayment on this type of deal the interest can quickly add up, eating into the remaining equity in your home.
With Vernon’s deal, as the borrower is making monthly repayments, the interest doesn’t compound and the loan remains the same size.
And Vernon’s rate of 3.49 per cent is significantly cheaper than Saga’s 5.65 per cent.
By comparison, Legal & General’s drawdown product, the Premier Flexible Lifetime Mortgage, has a rate of 3.50 per cent and is available from 55 years old. There are no fees, and the drawdown can be requested by the homeowner at any point.
More 2 Life also has a drawdown lifetime mortgage, the ‘Flexi Choice Drawdown Lite’ deal also available from 55 years old, fixed at 3.63 per cent, also with a no fee option.
As for other retirement interest-only options, Mansfield Building Society released a retirement interest-only mortgage with an added drawdown option last year, with a 2.99 per cent variable rate, £199 application fee and a £800 completion fee, up to a maximum of 40 per cent loan-to-value.
However, Mansfield’s offering doesn’t feature the offset facility, so you can’t add any of your own savings to lower your monthly repayments.
Are retirement interest-only deals working as intended?
Last month This is Money revealed that just 112 retirement-interest only mortgages were sold last year.
There are several reasons for this, the main one being stringent affordability rules which make most of these deals unobtainable for many borrowers.
A retirement-interest only mortgage differs from a standard interest-only mortgage in that the lender will be repaid when the borrower dies, or in joint cases, upon the death of the last surviving borrower.
They can also be repaid when the last borrower leaves the property to live elsewhere, for example by moving into residential care.
As part of this, the mortgage must be affordable on what is called an individual ‘sole survivor basis’.
For example, where a couple takes a loan, both partners must be able to show they can afford the mortgage payments on their own in the event that one partner dies.
On joint applications it is the lowest income that matters. It’s that income that would need to be used to make the monthly payments should the person with the higher income die first.
The underwriting process is also more complicated than a traditional mortgage for this type of deal.
The lender has to factor in pension income, investments, and other forms of income, plus the possibility of the death of one of the borrowers. This makes it hard for lenders to process a lot of these applications at once.
David Hollingworth, of mortgage broker London and Country, said: ‘Retirement interest-only is a sector of the market that has taken some time to grow but there’s now an increasing range of lender and product options.
‘Vernon Building Society has now expanded the options for borrowers further with a really interesting product development.’
Retirement interest-only vs lifetime mortgages and equity release
The FCA, Britain’s financial watchdog, defines the new wave of retirement mortgages as ‘interest-only mortgages for older consumers where, assuming there is no default, the loan is only repaid on a specified life event, usually the customer’s death or move into residential care’.
Customers must still be able to afford the ongoing interest payments, but ultimately the loan is repaid through the sale of the property.
A lifetime mortgage on the other hand is a form of equity release.
Borrowers choosing this option can opt either to pay interest monthly for as long as they wish and then switch to a roll-up plan, or go straight to rolling interest up.
The advantage of roll-up is that there are no monthly payments, so it can be an option for borrowers with low incomes.
The disadvantage is that interest charges compound over the years which can eat into homeowners’ equity significantly, leaving little to pay for care in later life or to pass on to children.
Equity release rates are also higher than standard mortgage rates as they factor in longevity risk – how long you’re likely to live before the lender gets their money back.