Soaring mortgage costs light fuse on pensions timebomb

The ongoing escalation in mortgage costs could have a serious impact on retirement plans and pension incomes for hundreds of thousands of workers and savers, warns Gary Smith, Partner in Financial Planning at leading UK wealth manager Evelyn Partners.

“Such a sudden ratcheting up of housing costs borne by both mortgage borrowers and renters is bound to have a disruptive effect on saving, and on some savers’ plans for retirement – particularly if the new rates environment is less transitory than expected,” he said.

“Given the state of the public finances, Rishi Sunak perhaps can’t be blamed for drawing the line under the major fiscal commitments that softened the blows of the pandemic and the cost of living crisis – so households should plan on coping with the cost of borrowing crisis themselves.

"Impacts could be felt right from younger savers looking to get on the housing ladder who cut back on pension saving, to the middle-aged who find themselves taking on marathon mortgages that run well past state pension age, to those who have retirement on the horizon and face tricky calculations around how long their pension pot will last.”

Moneyfacts today confirmed that the average two-year residential fixed-rate mortgage has topped 6%, and while a 0.25% base rate increase from the Bank of England is priced in on Thursday, a possible shock 0.5% hike would spark further ructions in the mortgage market. A think-tank warned at the weekend that the current explosion in mortgage costs is a graver problem than that seen in the 1980s and 1990s because home loans are now much greater compared to earnings, with monthly payments taking up a higher proportion of post-tax income.[1]

The report added that 800,000 people looking to remortgage their homes in 2024 will pay an average £2,900 a year more (a jump from £2,000 just a fortnight ago), with the average two-year fixed rate deal hitting 6.25% later this year. Another report has estimated that one million homeowners whose fixed deals expire in the second half of this year face an average rise in repayments of £5,304 a year. [2]

Annual repayments are now on track to be at least £15.7 billion a year higher by 2026 than they were prior to the Bank’s rate-hiking cycle that began in December 2021. The Bank’s most recent Monetary Policy Report in early May projected a £12 billion increase.

“How much of that £16billion is going to come from either reduced pension contributions or from savings that were intended for the medium to long term?” asks Smith. “With inflation negating wage rises and stealth income tax rises in operation, one fears quite a lot will.”

Smith identifies several areas for concern, each of which could contributed to a pensions crunch or a disruption of retirement plans.

1. A savings retrenchment

Those in their 20s and 30s who are looking to get on the housing ladder at the same time as funding sky-high rental costs are understandably struggling to save for anything else but a home deposit – and even if they do they will probably prioritise cash and ISA saving for the medium term rather than saving for retirement, which seems like a distant prospect. It seems unlikely that many will take the step of exiting the workplace pension that they have been auto-enrolled into, but many might well sacrifice additional matching contributions from their employer – above the a-e minimum – because it would mean they had to contribute more themselves and see their take-home pay fall.

This effect is obviously not restricted to younger savers: middle-aged mortgage borrowers, many of whom took on large mortgage debts in the era of rock-bottom interest rates, face rapidly rising monthly home loan payments and could well look to economise by reducing their pension contributions. A recent survey of 10,000 workers said 12% had cut back on pension contributions and a further 14% planned to make reductions next year – figures that are only likely to increase.[3]

This is likely to impact the self-employed most acutely, where low savings rates mean there is already a pension savings crisis.

2. Marathon mortgages

Data has confirmed a recent rise in the take-up of 30 to 40 year mortgages.[4] For younger cohorts this might be a coherent strategy as it is an effective way of keeping monthly repayments down, and indeed as such could protect their savings rate. This is particularly the case if they expect their incomes to increase or a windfall to arrive so that they can move on to shorter-term loans.

But the overall costs of such loans are high, and equity is built up very slowly in the early years because of the high proportion of payments going towards interest charges, so such borrowing will deplete finances if homeowners keep remortgaging with very long terms – which will be tempting as people become accustomed to their monthly repayments being at a certain level.

With the average age of first-time buyers now into the 30s, it’s not hard to see how 35 and 40-year loans could alter their retirement landscape.

3. Middle-age borrowing

Problems are even more visible for middle-aged borrowers whose mortgage costs are jumping, and who might also feel compelled to take on longer-term loans to keep monthly payments down, ending up with a mortgage that stretches well past their planned retirement age and perhaps well past state pension age. This could cause all sorts of difficulties – the obvious one being that unless action is taken the assumption of a mortgage-free retirement must be revised and cash-flow projections must factor in potentially hundreds of pounds a month in loan repayments.

Savers will be increasingly tempted to use their 25% tax-free lump sum at pension access age 55 (or 57 after 2028) to pay down their mortgage. 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.

4. Working for longer

With mortgages being paid off later and later, repayments potentially running past state pension age and savings depleted, many will feel compelled to work for longer, so we could see later retirements for half a generation of borrowers hit by the current crisis.

There is already some evidence of people putting off retirement, with fewer people aged 60 to 65 retiring this year.[4] More than one in ten people aged 65 or over were either in work or job hunting in the three months to April, and 12% of over-65s still economically active - which is the highest level since records began in 1992.[5]

This might fit with the Government’s objective of keeping more people economically active and in the workforce but it might not be how many savers envisaged their later life panning out.

5. Retirement living standards hit

Even for those who do not need to take drastic measures or to change their retirement plans, the fact is that their standard of living could be lower than expected after leaving work. Just as the cost of living crisis is eating into retirement savings, so the cost of borrowing crisis will for those with outstanding debts.

Let’s not forget that while inflation might start to come down, it is a one-way street: we will be living with the last 18 months of price rises forever and inflation is depleting the real incomes of not just those who are already retired and drawing from their pension, but also those for whom retirement is not yet imminent. Even if those in the later phases of pension saving are determined to maintain their contributions, the raised cost of borrowing could hit, for instance, ISA saving which was intended to supplement a pension.

NOTES

[1] Resolution Foundation, 17 June 2023: “Mortgage crunch deepens with £15.8 billion repayments rise now on track to bite by 2026”

[2] Oxford Economics, June 2023

[3] LCP, 14 June 2023

[4] Age UK, 17 June 2023

[5] ONS/Rest Less