Could you be putting your retirement at risk with a 40-year mortgage?

Increasing numbers of buyers have opted for longer-term mortgages to cope with the cost of living crisis but could they be putting their retirement at risk?

Mortgages
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Increasing numbers of buyers have opted for longer-term mortgages to cope with the cost of living crisis but could they be putting their retirement at risk?

HSBC this week became the latest lender to increase its maximum mortgage term, upping it from 35 to 40 years in line with many major lenders, a move that it said would “help make mortgages more manageable with lower monthly repayments and homeownership a reality for our customers.”

But as buyers get on the property ladder later and borrow for longer, there are warnings that they may be putting their retirement at risk.

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Analysis by Standard Life suggests increasing pension contributions from age 55 rather than having to make mortgage repayments could boost your retirement pot and lifestyle.

The rise of 40-year mortgage terms 

Longer term or so-called marathon mortgages have become popular amid the cost of living crisis.

That is no surprise with mortgage pricing rising in response to higher swap rates, Bank of England rate rises and economic uncertainty. 

Borrowing for longer helps spread the cost of a mortgage, lowering the monthly repayments. This makes mortgage borrowing cheaper in the short-term on a monthly basis 

The difference means someone with a £200,000 mortgage at an interest rate of 5% would repay £1,169 a month over 25 years. 

If they lengthened their mortgage term to 35 years that repayment would drop to £1,009, while a 40-year term would reduce repayments to £964 per month. That means a borrower could save £205 per month by taking a mortgage out over 40 years instead of 25.

However, borrowers will pay more interest in the long-run.

Around two-thirds of mortgages have terms of up to 40 years, according to Moneyfacts.

By the end of 2022, more than half of first-time buyers and one-third of home movers were borrowing over terms of more than 30 years, according to UK Finance, which says the trend is starting to level off.

Retirement risks 

Keeping mortgage costs low will be a priority for many buyers, especially in the current economic climate. But there are risks to borrowing for longer beyond paying extra interest.

Standard Life says clearing your mortgage a few years before entering your golden years means you won’t need to factor housing costs into your retirement planning.

Additionally, the money that was going towards mortgage repayments could go towards your retirement pot instead, which the provider suggests could “significantly boost” its value,

That is because your salary is likely to be higher as you get older and towards the end of your career, meaning you have more to put into your pension and boost its value.

Analysis by Standard Life found that a 22-year-old who begins working on a yearly salary of £25,000 and pay the standard monthly auto-enrolment contributions - 5% for employees and 3% from employer - could build up a total retirement fund of £461,000 by the age of 66.

However, topping up contributions by 4% for 10 years from the age of 55 - the age at which a 25-year mortgage term taken out at the age of the 30 would be paid off - could result in a total pot of £513,000 – £52,000 more than if no tops up were made.

Even increasing contributions by just 1% from age 55 until retirement at age 66 could lead to £13,000 extra in your pension pot, Standard Life says.

If you have enough money to afford 12% contributions from age 55 until retirement age, your pension pot could end up worth £90,000 extra at £551,000

This assumes annual investment growth of 5%.

“Interest rates have rocketed since the middle of last year and so it’s understandable that people are looking for longer mortgage terms to ease the monthly strain,” says Dean Butler, managing director for retail direct at Standard Life.

“It won’t be possible, or even sensible, for everyone to stick to a shorter mortgage term, however it’s worth considering the potential retirement impact of any decision,” 

“There are obvious benefits to being mortgage free in retirement itself, but additionally having the option to swap mortgage payments for pension contributions in those valuable years leading up to retirement can have a significantly positive impact on your pot, and as a result on your standard of living in retirement.”

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The impact of changing your pension contributions on your pension pot
Standard contributions (5% employee, 3% employer) from 22-66Standard contributions till 55 and (6% employee, 3% employer) from 55-66Standard contributions till 55 and (7% employee, 3% employer) from 55-66Standard contributions till 55 and (8% employee, 3% employer) from 55-66Standard contributions till 55 and (9% employee, 3% employer) from 55-66Standard pension contributions till 55 and (10% employee, 3% employer) from 55-66Standard contributions till 55 and (11% employee, 3% employer) from 55-66Standard contributions till 55 and (12% employee, 3% employer) from 55-66
£461,000 £474,000£487,000£500,000£513,000£526,000£538,000£551,000
Row 2 - Cell 0 +£13,000+£26,000+£39,000+£52,000+£65,000+£77,000+£90,000

The best of both worlds 

Choosing between mortgage payments and pension contributions doesn’t have to be an either-or scenario.

There is an argument that taking out a longer-term mortgage when you are younger can leave you with extra cash to put into a pension. 

Borrowers also have the option to reduce the mortgage term by overpaying when they can afford it and by remortgaging.

Scott Taylor-Barr, financial adviser at Barnsdale Financial Management, says the term of the mortgage is a financial planning tool just like any other. 

“A 40-year mortgage term may be the appropriate way forward for a first-time buyer, with a review of that at their first remortgage, when it may be decided that they can afford to reduce the term, due to interest rates at that time or an increase in their income,” he says.

“Likewise, if someone is coming off an ultra-low interest rate deal and their new repayments are putting them under too much financial stress, a longer term can help alleviate that.

“I would be very surprised if someone took on a mortgage in their 20s on a 40-year term and maintained the same term at every step of the mortgage life thereafter.”

Butler says there is a trade-off with mortgage payments being made for longer which increases the chances they will be paying it off right up to or into retirement.

“It’s a catch 22 situation in so far as owning your own home in retirement is a major benefit from a cost perspective but people will need to balance that against whether a longer mortgage also leaves enough head-room for retirement saving too,” he says.

Marc Shoffman

Marc Shoffman is an award-winning freelance journalist specialising in business, personal finance and property. His work has appeared in print and online publications ranging from FT Business to The Times, Mail on Sunday and The i newspaper. He also co-presents the In For A Penny financial planning podcast.