Another way of paying the mortgage
Paul Slade looks at the tax benefits of using a pension in a home loan
Sunday 30 June 1996
Mortgage borrowers are normally steered towards repayment loans that are gradually repaid during the term of the loan, or towards interest- only loans with extra contributions paid into an endowment or personal equity plan (PEP) designed to repay the loan at the end of its life.
But pensions provide a fourth and often overlooked option. As with an endowment or PEP-backed interest-only mortgage, you pay the lender only the interest due on your loan every month. At the same time, you pay regular contributions into a pension scheme.
The mortgage and pension are set up to mature on the same date. This means you can use part of the pension fund to repay the capital to the lender.
It is most common for a personal pension to be used for mortgage repayment, although some employee pension schemes can be used in this way.
By far the biggest advantage of a pension mortgage is its generous tax treatment. The Government is so keen to encourage people to save towards their own retirement that it gives tax relief at the investor's highest rate of contributions. Those paying 40 per cent will find that, for every 60p they pay into their pension, the Government effectively chips in another 40p. For standard rate taxpayers, the Government contributes 24p in every pounds 1.
The money in the pension fund also grows free of tax. When the plan matures, you can take up to a maximum of 25 per cent of the accumulated pension fund tax-free. This is the part used to repay the mortgage. The remainder, which is taxed, must be used to provide your retirement income.
The tax advantages for higher-rate taxpayers means it is often big, self- employed earners who find these schemes most useful.
Because you are funding both your mortgage and your pension in one, the premiums you will be asked to pay on a pension mortgage may look expensive compared with those for other mortgage repayment vehicles, such as endowments or Peps. For a true comparison, however, you should also include the cost of the separate pension provision you will still require if you opt for another repayment vehicle.
A potentially more serious problem is that using part of your pension to pay off the loan could leave you with insufficient funds to pay your way in retirement. Amanda Davidson, of Holden Meehan, independent financial advisers in London, says: "If you use part of your pension fund to repay your mortgage, it's not going to be there for you as a pension. You need to be very careful to make sure you have an adequate pension as well as funds to repay your mortgage."
Michael Baugh, of independent financial adviser DBS, agrees. "You're using up your pension fund, which can be dangerous. Most people need to use as much of the fund as they can to provide a pension income because, by and large, they underfund their pensions."
In addition, the funding of your pension mortgage could run into trouble if your career involves switching between self-employment and full-time employment. While the self-employed can only invest in a personal pension, an employee may have the opportunity to join an occupational scheme - an opportunity that should almost always be jumped at. Some personal pension schemes allow you to stop paying premiums without any penalty - the fund will simply continue to grow and mature on the agreed date. And you may be able to use your new occupational scheme as an alternative way to repay the loan, or use some other investment vehicle such as a Pep. But you must review your situation regularly to make sure your savings are on course to meet the loan requirements.
The fact that pensions cannot be drawn before the age of 50 means that it will be impossible for the borrower to repay his or her loan any earlier. For this reason, pension mortgages are usually considered unsuitable for younger borrowers, who are unlikely to want to wait until retirement before paying off their mortgage.
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