A new type of mortgage is establishing itself as an option for older borrowers who want to free up equity from their home, or combine paying for their home with saving for retirement or care costs.
Retirement Interest Only (RIO) mortgages are becoming more common and available from a wider selection of lenders after the regulator, the Financial Conduct Authority (FCA), cut red tape and eased regulations on them.
In March 2018 the FCA reclassified them as standard mortgages. Previously they’d been classed with equity release as lifetime mortgages, but after a consultation the mortgage industry backed the changes allowing a wider range of lenders to step into the market and offer them.
RIO mortgages require borrowers to only make monthly interest payments until they die or go into long-term care, at which time, lenders get their loan repaid by the house being sold.
They’re similar to normal interest-only mortgages where you only make monthly interest repayments and rely on an alternative investment method, alongside house price growth, to repay the principal loan.
However, there are two main differences to a standard interest-only mortgage. Rather than relying on an alternative investment to pay off the main loan, it’s repaid when the house is sold, when you die or when you move into long-term residential care.
The second difference is that to be accepted for an RIO mortgage you only have to prove you can afford the monthly interest repayments because the method of repaying the loan is already agreed.
They’re targeted at older borrowers, typically people over 55 or approaching retirement, though there’s often no minimum or maximum age requirement.
The FCA wants to encourage more people to consider RIO loans to counter the common problem many interest-only borrowers have of having no repayment vehicle in place to repay their loans.
As they become more established, RIO mortgages are being sold by general mortgage brokers and lenders, whereas lifetime mortgages tend to be sold by specialist equity release providers.
Because of the lower monthly repayments RIO mortgages have, RIO loans are more suitable than equity release products for borrowers in retirement with a secure retirement income source like a defined benefit pension scheme.
If you have a less secure income or don’t want to commit to regular monthly repayments for the rest of your life, equity release may be a better option.
However, if you’re semi-retired, still working part-time, with a regular income but not enough to borrow through an RIO loan, until recently, if you wanted to borrow at this stage of life, a lifetime mortgage was your only option. Now, new hybrid products are available like optional payment lifetime mortgage deals, where you can pay some or all of the monthly interest, but have the option to stop paying and for interest to be ‘rolled-up’ for a period and added to the overall loan.
Lifetime or equity release mortgages are loans secured against the value of your property that allow you to release some of the equity you’ve built up.
They’re available to over-55s and the loan is repaid when the last person living in the property dies, sells the home or goes into care. RIO mortgages work in a similar way.
With a lifetime mortgage you’d normally have a larger amount to repay at the end because you don’t make monthly interest repayments. Instead, they’re deferred, ‘rolled-up’ and added onto the total loan value to be repaid.
They can be more expensive because the interest charges are compounded over time which adds extra interest and reduces equity in the property, leaving less for care costs or to leave as an inheritance. However, they can be a good option for people on low incomes. Also, most lifetime mortgages now come with a no negative equity guarantee, so the borrower never owes more than the value of their home.
With a RIO mortgage you only pay the interest each month, so overall repayments are lower.
RIO mortgages are similar to standard interest-only mortgages but the ‘retirement’ element means there is no defined end date, when the capital has to be repaid by.
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You repay a RIO in two ways. Initially through recurring monthly interest payments and, eventually, the outstanding capital balance when the house is sold after you die or move into long-term care.
The FCA changed the terms of the Mortgage Credit Directive because it thinks RIO mortgage are a simpler product than equity release, don’t involve interest being ‘rolled up’, have a simpler selling process and sellers need less advanced qualifications to sell them.
The FCA wants RIO mortgages to be more widely available to older borrowers with a steady income, giving them more options and providing an alternative to downsizing or using equity release.
With a RIO mortgage you don’t have to prove a repayment plan for repaying the capital you borrow so it’s ideal for older borrowers who don’t earn a regular wage or plan on retiring before the end of the mortgage term.
Another advantage is that the mortgage term is flexible and some lenders have no maximum age rules when the mortgage term ends.
Because you’re paying back the interest each month and it isn’t rolled-up to add to the overall amount you owe, it’s cheaper and likely you’ll leave a larger inheritance.
RIO mortgages let you unlock some of the equity in your home to pay off outstanding debt, can help you avoid having to downsize to a smaller property and are usually cheaper than lifetime mortgages.
You still need to pass affordability checks to prove you can afford the interest-only repayments and because you repay the capital by selling the property, you’ll have less to pass onto relatives than if you cleared a repayment mortgage.
Just like with any other mortgage, your home is at risk if you don’t keep up with the monthly mortgage interest repayments.
The amount you can borrow is linked to your earnings, which, later in life, could be limited, so you may not be able to borrow as much. Borrowing levels are also linked to your loan-to-value (LTV) ratio, the proportion of the value of the property you own.
One concern with relaxing the rules is that RIO mortgages can be sold by brokers or Independent Financial Advisors (IFAs) who don’t have qualifications for selling equity release products.
There are concerns this may lead people to get an unsuitable product when there may be better options available for them and that the rules should have remained the same so that all types of products for older borrowers required the same qualifications and worked from a level playing field to reduce the possibility of mis-selling.
It’s possible to switch from either a repayment mortgage or an interest-only mortgage to a RIO mortgage, but may mean you have to take new affordability assessments with a new lender which could cause you problems, depending on your circumstances and if you need to borrow more.
You can remortgage from an interest-only mortgage to an ROI product, using the sale of the property as security. This can help borrowers on an interest-only deal who have no way to repay the capital.
There are more lenders offering RIO mortgages, including traditional high street lenders. Nationwide Building Society, one of the UK’s biggest lenders is expected to launch a RIO product soon.
Rates aren’t as cheap as repayment mortgages for the same LTV ratio. For instance, Aldermore Bank, the first lender to enter the market, launched a three-year fixed rate deal for borrowers with a 60% LTV ratio for 4.0% with a £999 product fee.
As more lenders enter the market rates are becoming more competitive with more discounted rates.
If you’re considering a RIO mortgage or a lifetime or equity release mortgage, shop around for the best deal and take independent financial advice to get the right product for your circumstances.
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Last updated: 31 May, 2019