RIO "not the answer" for most interest-only borrowers, Royal London warns

Royal London believes that "very few will be able to afford the cost of servicing a mortgage debt" in addition to covering basic living costs after they retire, and would fail affordability tests applied by RIO lenders as a result.

For RIO mortgages, the lender has to look at how the mortgage interest will be paid after one partner dies, meaning that it is the income when one partner becomes a widow or widower that determines if the mortgage is affordable. With many pensions stopping when someone dies or passing on only a modest percentage to a surviving partner, Royal London says a mortgage that can seem affordable when both partners are still alive can become unaffordable if one dies.

According to the FCA, around 10% of interest-only loans are not backed up with any repayment plan, while 50% are likely to have a shortfall. There were 550,000 interest-only mortgages borrowers over the age of 55 in December 2018, representing about a third of the total 1.66mn, according to UK Finance.

This suggests up to 275,000 borrowers who are already at or approaching retirement face choosing between downsizing; working for longer, taking out an equity release loan or applying for a retirement interest-only loan in order to avoid repossession.

Becky O’Connor, personal finance specialist at Royal London, said: “The introduction of RIOs may give false hope to hundreds of thousands of borrowers with interest-only loans they can’t pay off at the end of the term.

"These loans might seem like the perfect solution, but in practice, because of affordability criteria, they will not be the answer for most people.

“Generally speaking, pensions are not designed to cover housing costs. ‘Target pot’ estimates assume that people who are homeowners have already paid off their loans and will only need to cover other essential living costs, like food and energy bills, in retirement.

“So even those who have a ‘decent’ pot size of £260,000 might find they wouldn’t have enough income in retirement to pay RIO mortgage repayments and still maintain a decent standard of living.

“With many people not saving enough in a pension even to cover basic living costs in retirement, many borrowers are likely to have an application for a RIO mortgage rejected, or be offered a much lower amount than their shortfall.

“It’s likely that uptake of RIOs will therefore be reserved for those endowed with the most generous pensions, or income from other sources such as property or work.”