After the debacle of the pension scandal in the mid 90s and the continuous under performing personal pension plans many in UK turned and are still turning to properties as an investment for their retirement. The housing market has certainly not failed them as it relentlessly continues to grow. But I question how much of this benefit is being lost to the mortgage lender?:
A study of the mortgages being taken out on Buy to Let properties will show that it is mainly of the Interest Only type with no investment plan to pay the loan at the term end. The assumption is that the value of the property will never stop to grow and at term end it will be sold and the net proceeds after repaying the mortgage - the original amount- will then be a lump sum to be used towards retirement. Hold on! that is not quite right. I forgot to subtract the Capital Gains Tax from the sale proceeds too before it can be had towards a pension.
What would have been the final outcome if the mortgage had been of the Capital Repayment type? There would have been no more mortgage to repay at term end and instead of selling off the property and pay Capital Gains Tax the home owner would continue to let out the property and earn an income as a pension assuming term end is at retirement. In other words he would be more in control and with more choices at term end.
But why dont Buy to Let owners use this type of mortgage instead? The reason is finance:
The following example will demonstrate the reason why.
Lets take a 25year loan for a £180,000 Property with £135,000 mortgage at 5.25%, monthly payment on Interest Only would be £591 against a rental income of £700.
Thus such investment would be self financing.
However had the mortgage been of the Capital Repayment type the monthly payment would be £809 against a £700 rental income rendering the investment not self financing.
Thus here is the reason for sticking to an Interest only mortgage with the winner being: The mortgage lender who would have received interest paid on the whole amount throughout and at term end be paid the original amount.
Could there be a solution to such a time bomb? Yes, if only the interest could be around 2% because then the capital repayment monthly payment would be £572 i.e. even cheaper than the above Interest Only monthly payment, and lower than the rental income. It would render the safer Capital Repayment method self financing too but is there such a mortgage rate?
Yes and enquire here for a safer landing at pension time.
Louis d'Espagnac
Chief Executive
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Retired people can try reverse mortgages which are designed to enable elderly homeowners to unlock illiquid wealth tied up in their housing equity to generate income. The equity built up over years of home mortgage payments can be paid to you. But unlike a traditional home equity loan or second mortgage or bad credit mortgage, no repayment is required until the borrower(s) no longer use the home as their principal residence.
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