Pension tension: the challenges for older borrowers
Published: 19 June 2015
Over a third of new mortgages being taken out today will extend beyond the borrower’s 65th birthday, delegates at our ‘pension tension’ conference were told last week. But less than 1% of all new lending (including equity release lifetime mortgages) was to this group, illustrating one of the many conundrums that exist in serving the needs of older home-owners in the future.
The conference highlighted a number of recent developments, including the introduction of pension reforms, which could have a significant impact on retirement borrowing. And it focused on the impact of some much longer term trends – including demographic shifts that are changing the landscape over decades.
The conference also helped crystallise an important distinction between borrowing into retirement, and borrowing by customers in retirement.
The former is a much larger phenomenon. Lengthening mortgage terms and the older age at which some buyers are entering the property market means that almost 35% of new loans are not expected to be fully repaid until the borrower has passed the nominal retirement age of 65. However, most of these are paid off shortly afterwards. Around 80% of mortgages extending past the borrower’s 65th birthday are due to be repaid before the customer turns 70.
In contrast, borrowing in retirement occurs on a much smaller scale, and has been in decline since 2007 (apart from a small tick-up last year attributable to strong growth in lifetime lending). The value of mortgages (excluding lifetime mortgages) taken out by borrowers aged over 65 declined to around £1 billion last year – accounting for only 0.5% of total annual advances of more than £203 billion.
Trends affecting retirement borrowing
One factor likely to have a significant impact on retirement borrowing is the rapidly ageing population of the UK. There are currently more than 11 million people aged 65 or over (accounting for around 17% of the population). But the total is expected to grow to around 17 million (or almost 25% of the population) by 2034. Moreover, within this group, the largest percentage growth will be in those aged 85 or older. The number in this group is set to more than double to around 3.4 million from around 1.5 million today.
Another important factor is the amount of housing equity owned by pensioner households. A recent index published by equity release specialist Key Retirement put the amount of property wealth owned outright by retired home-owners at almost £874 billion. Meanwhile, earlier this year, the English Housing Survey showed that for the first time the number of homes owned outright exceeded the number being bought with a mortgage. And it is older households that are more like to own their home outright.
But, despite the growing wealth of the UK’s ageing population, borrowing by those aged over 65 has been falling – by number of loans and value – since 2007. As Chart 1 shows, total borrowing by those aged 65 (including lifetime mortgages) was around £1.7 billion last year, accounting for less than 1% of all advances.
The tick-up in borrowing by this group last year was driven by strong growth in lifetime mortgages, and this has been predicted to continue by a number of commentators. Lifetime mortgages accounted for around half of all borrowing by the over-65s reported in our data.
Chart 1: Borrowing by those aged 65 and over, by volume and value
As one would expect, people will generally have different reasons for taking out loans at different stages of their lives. The pattern for choices later in life is often set by the age at which people are able to get on to – and then move up – the property ladder. Among borrowers aged over 65, there is almost an even split between those taking out a loan to move home and those remortgaging.
Chart 2: Distribution of loans advanced by age and type, 2014
The English Housing Survey shows that trends in borrowing over a long period have contributed to a change in the age profile of households that have mortgages. There has been a decline in the proportion of mortgages held by younger households (those aged up to 44), and a corresponding increase in the proportion held by older people. There are a number of reasons for this, including an overall decline in first-time buyer numbers, the rising age at which some of them are entering the property market, and lengthening mortgage terms.
Chart 3: Distribution of households buying with a mortgage by age, England
Our recent conference also provided an opportunity to update our analysis of loans extending into retirement, which we last published in April 2014. As before, we have assumed a nominal retirement age of 65 – even though the age at which people actually retire is generally rising but becoming less certain. As Chart 4 shows, the proportion of loans expected to extend beyond the age of 65 is continuing to increase, and is approaching 35%.
Chart 4: The number and proportion of mortgages extending to age 65 and beyond
In recent times, a growing proportion of mortgages extending beyond the age of 65 have been taken out by home movers. They now account for around half the total, as Chart 5 shows. But the number of first-time buyers taking out mortgages that will mature beyond the age of 65 has also been edging upwards – and accounted for 21% of the total in the fourth quarter of last year.
Chart 5: Mortgages extending beyond age 65 by borrower type
An increase in the proportion of first-time buyers with longer mortgage repayment terms is contributing to this trend. Chart 6 shows that more than half of first-time buyers are now taking out a mortgage that they expect to repay over a term of longer than 25 years.
Chart 6: Mortgages advanced to first-time buyers, interest-only and with repayment terms of more than 25 years
Longer terms make monthly repayments less expensive, and some first-time buyers may be choosing this option in response to affordability constraints, especially now that the option of borrowing on an interest-only basis is not generally available to them.
Perhaps the key underlying messages from our data are:
- Demographic trends – particularly the UK’s ageing population – means there is a growing potential market of older people.
- Despite this, lending to those in retirement has been falling for much of the last decade.
- There is, however, an increase in the number of loans extending beyond the age of 65 – but there will be limits on how far this trend can continue.
The regulatory approach
In a period in which incomes have been growing more slowly than house prices, the challenge for many borrowers is how to demonstrate that they can afford the mortgage that they want. New borrowers are now largely unable to borrow on an interest-only basis, and the Financial Policy Committee’s limit on the amount of lending by firms at a multiple of more than 4.5 times income imposes further constraints on some of those seeking a mortgage. For an increasing number of borrowers, an extension to their mortgage term may be a sensible approach.
The Financial Conduct Authority (FCA) insists that the key requirement for lenders is to assess the affordability of borrowing for individual customers. Neither age nor even employment status are the primary concern. In the mortgage market review, the FCA said:
Lenders must consider whether the borrower can continue to afford the mortgage following a known change in their income, such as retirement. Our aim is to prevent unaffordable lending in retirement, not to prevent all lending into retirement.
However, the issues for lenders are complicated. Some borrowers may want to work beyond their expected retirement age, but are their plans really plausible? Pension income will also be an important consideration for some older borrowers and, for many with defined contribution pensions, retirement income may by uncertain. But for those with defined benefits pensions, retirement income may be more reliable than what they expect to earn from employment.
Meanwhile, recently introduced reforms have given borrowers much greater freedom over how they use pension savings that may have been intended to buy an annuity to provide a retirement income. Lenders will have to look carefully at individual borrowers’ plans for repaying their mortgages – as well as the potential for their circumstances to change unexpectedly.
The CML's retirement borrowing work
Retirement borrowing is a key issue for lenders. The data shows there is growing consumer demand, while the needs of people in retirement – and even retirement age itself – have become less certain. Regulators will scrutinise developments carefully – and pension reforms will add complexity. But the industry must lead the debate. And we have established an initiative to help focus on the issues, which we see targeted on four key areas:
- How will regulators and the government view developments? Are the actions taken by different regulatory and consumer protection bodies – including the FCA, the Prudential Regulation Authority and the Financial Ombudsman Service – compatible with each other, and will they allow the market to develop to meet the needs of consumers, while providing proper safeguards? Or is there a need for clarification or amendment? The industry needs to help ensure there is a coherent approach, and to seek clarity so that products can be developed in a more certain environment.
- What kinds of products will meet consumer needs in this developing market? Will existing products suffice or, if there are to be new ones, what should they look like? Do consumers need a product that can ‘morph’ from mortgage to lifetime mortgage? Above all, we need the right kind of approach to innovation, with a focus on delivering good outcomes for consumers.
- How will the needs of consumers evolve, and how will this affect future demand? As an industry, we need to have a clearer understanding of this so that we can plan accordingly.
- What will be the wider effect of pension reform on mortgage and housing markets? New rules have only just come into effect, and we will need to understand how they are working in practice and over time, and how they will affect future retirement borrowing.
As we said when launching our work on retirement lending earlier in the year, this is an agenda for our times. But it will evolve in the future, with demographic changes set to deliver a huge increase in the number of older people in the UK.
There is already a significant – and growing – amount of borrowing, part of which will be repaid after nominal retirement age. At the same time, borrowing in retirement has been declining, aside from the growth in lifetime mortgages. There are major issues for regulators, and pension reform provides more options for consumers while adding to complexity. But the industry must be at the forefront of the debate about future needs, and the CML will continue to provide a forum in which the discussion can evolve.