It’s common for people who can access their pension to not take an income from it. This is usually because it doesn’t make financial sense based on considerations like tax, investment return, retirement plans or simply not needing the money.
However, when it comes to these people needing a mortgage, this can cause a problem. Many lenders, even those that accept pension mortgages, will usually still need to see a sufficient income.
This can be frustrating for people who are asset rich and cash poor because, though choice, they and being prudent with their finances and/or are acting on professional advice.
This can lead people believing that they either need to draw down funds they don’t need or consider options they don’t want (i.e. Lifetime Mortgages).
It could even mean that they don’t take the mortgage they need and put their plans on hold.
This is where monetising pension pots for mortgages could be useful.
Monetising Pension Pots for Mortgages
There are some lenders who will translate the value of a pension pot into an income for mortgage affordability purposes, but without the need to draw anything from the fund.
This means that somebody could take out a mortgage based on their pension ‘income’, keep their funds fully invested and have no bearing on their income tax position.
How Does it Work?
It may sound a little strange that somebody can take a mortgage out based on income they are not in receipt of.
However, the principle behind this is that some lenders will calculate affordability on what a borrower could take if they needed to, rather than what they are currently taking.
This means that prudent borrowers of retirement age aren’t penalised for not doing something that doesn’t make financial sense when trying to get a mortgage.
This is a similar concept to lenders who accept profit for Limited Company Directors (instead of dividends). It’s common for Company Owners to keep funds within their business, usually for tax purposes or not needing the money, but could draw it if they want/need to.
How is Affordability Calculated?
There are usually two ways –
- % of Pension Pot = Income used
Let’s say somebody has a pension pot of £1m.
For the percentage option, a lender may take a percentage (say 5%) of the pot and use this as the ‘income.’ This would be £1m X 5% = £50,000 ‘income’.
If the lender offers a multiple of 4, this would mean a loan amount of £200,000.
- Pension pot divided by the income needed = mortgage term
Now, let’s say that you need to borrow £400k so the percentage option isn’t sufficient.
In order to borrow £400k, you would need an income of £100k (4X).
£1m divide by £100k = 10.
In this instance, the lender may consider a £400k mortgage over 10 years.
What Information does the Lender Need?
The lender usually require standard information when assessing an application such as –
- Identification
- Proof of address
- Bank statements
- Pension statements
In addition, they will usually carry out a credit check.
When monetising pension posts, the lender will usually make an assessment to ensure sustainability. They will also carry out sense checks with regards to affordability in retirement.
It’s also common for lenders to require something in writing from the acting IFA / Wealth Manager. This is to confirm access to the pension and that this is a viable strategy taking into account pension planning.
Is Monetising Pension Pots for Mortgages a Good Idea?
In certain situations, monetising pension pots for mortgages can be useful. This is usually because taking the funds required from a pension pot could be detrimental for either tax or investment return purposes. This should be clarified with specialist advice from a Wealth Manager and/or an Accountant as appropriate.
Of course, the most important thing is that it needs to be the right thing to do. As with any type of retirement mortgage / later life lending, the alternatives should be carefully considered along with the pros and cons before making a decision.
In addition, it’s usually good practice for a mortgage adviser who understands this sector to work closely with the acting Wealth Manager / Accountant as appropriate. This ensures that all factors are considered before giving the right advice and achieving the right outcome.
