UK’s mortgage relief measures risk a financial shortfall in later life

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Steps by banks and building societies to help UK borrowers cut their monthly mortgage payments risk storing up financial trouble later in their lives, as they face a higher total interest bill and lower income in retirement, financial advisers warned.

Following the surprise announcement by the Bank of England that it was raising interest rates by half a point to 5 per cent, borrowers were hit by another wave of mortgage rate rises last week, leaving households coming off a fixed-rate deals in the months ahead facing a “mortgage shock”.

Big lenders, including Barclays, Halifax, HSBC, Nationwide, NatWest, Santander, TSB and Virgin Money pushed up the cost of their products. Santander raised rates twice in a week.

The surge in mortgage costs has piled pressure on the government. An owner of an average priced property with a 25 per cent deposit, who is refinancing a two-year fixed-rate deal, would have to pay an extra £580 a month on a new fix, according to consultants Oxford Economics.

In the wake of the BoE’s decision, chancellor Jeremy Hunt brokered a deal with the UK’s biggest lenders for a “mortgage charter” designed to give struggling borrowers options for slimming — at least temporarily — their monthly mortgage payments as their budgets groan under the weight of higher bills. 

Measures include the option of switching from a capital repayment mortgage to an interest-only loan; or extending the term of their mortgage, which spreads repayments out over a longer period. In either case, borrowers can ask for six months under the new arrangement with no effect on their credit score. After that, if they wish to prolong it, they must take an affordability test with the lender. 

The initiative could provide a lifeline for those on the cusp of affordability. But property analysts and financial advisers fear that those who choose not to switch back risk damaging their finances in the long term. 

Extending a mortgage terms beyond the historical norm of 25 years is a long-running trend, particularly among first-time buyers. Stretched by affordability tests and high house prices, they have been increasingly signing up to “marathon mortgages” as long as 40 years.

The proportion of first time buyers taking out mortgages of at least 35 years more than doubled over the 12 months to March to 19 per cent, according to the latest data from UK Finance. There was a similar trend among those moving house with the proportion of loans of between 30 to 35 years rising from a fifth to a quarter.

For many it can be the only way to get on or move up the housing ladder. One consequence, however, is a bigger total interest bill over the life of the mortgage.

Extending a £200,000 mortgage from 25 to 35 years would cost almost £39,000 more in interest, assuming 3 per cent interest over the life of the loan. At £400,000, that 10-year extension means an extra £77,500, according to investment broker AJ Bell. 

“Before households leap to take advantage of the new flexibility they need to really consider the long-term impact,” said Laura Suter, AJ Bell personal finance analyst. 

Moreover, the relief provided may not be as great as borrowers hope, warned Adrian Anderson, director at mortgage broker Anderson Harris. “If you’re coming off a rate of 2 or 3 per cent to a current rate of 5 or 6 per cent, even if you move to an interest-only mortgage the problem is you’re still paying far higher monthly payments than you were before. It may not be enough of a saving for a lot of people.”

Financial planners also fear the mortgage crisis will seriously affect pension saving. Officials figures from March found 38 per cent of working-age people were not saving enough even before higher housing costs to provide them with an adequate income in retirement relative to their pre-retirement earnings. The figure rises to 55 per cent for higher earners. 

Signing up to a mortgage term that extends into retirement compounds this problem, said Gail Izat, managing director for workplace at Standard Life. “I absolutely understand why easing the short term burden by adding to the mortgage term makes sense. But it does exacerbate that savings gap and we need to think about how we can mitigate that.”

Gary Smith, partner in financial planning at wealth manager Evelyn Partners, fears “quite a lot” of borrowers will fund pricier mortgages by either reducing pension contributions or from savings that were intended for the medium to long term “with inflation negating wage rises and stealth income tax rises in operation.”

Reducing or pausing pension contributions will mean missing out on employer contributions and government tax relief. And without a feasible plan to get their savings back on track, they may need to work longer to achieve the quality of life they had planned in retirement.

Some may also be tempted to solve their mortgage problems by tapping into the 25 per cent tax-free lump sum from their pension pot when they reach 55 (rising to 57 from 2028).

“This is by no means an unusual strategy but it obviously leaves less savings to provide a retirement income and the mortgage crunch could mean it is employed by savers with less of a pot to work with,” Smith said.

With little certainty over when inflation might cool and allow interest rates to drop back, raised housing costs are “bound” to have a disruptive effect on saving, he warned, particularly if higher inflation proves more stubborn than expected. 

The government said the best way to help households was to drive down inflation but it had offered “significant” cost of living support and put the mortgage charter in place to ensure “borrowers and savers are protected from rising costs.”

It added: “We always want to encourage pension saving and with automatic enrolment an extra £33bn was saved in 2021 compared to 2012.”