This case study looks at how a RIO mortgage could help your client move into a new property from a divorce
Derek, 55; working as an engineer
This case study does not represent real people and is for illustrative purposes only.
Derek is 55 and works as an engineer. He has always been financially savvy and is proud of what he’s saved for his retirement. However, his recent separation from his long-term wife Layla has derailed his plans.
He is keen to purchase a smaller property that will meet his needs – in an area closer to amenities and to his two grown up children in Gloucestershire. He’s looking at a two-bedroom semi-detached property valued at £320,000.
He has substantial equity in the property he currently shares with his soon to be ex-wife which has risen in value whilst they have lived there.
Due to the equity he has in the property and the uncertainty on his options after separation, he is seeking further advice from his mortgage broker. His mortgage broker has advised he cannot currently source a traditional mortgage as the maximum amount he can borrow falls short of his requirements.
What he wants
- To move closer to his two children and away from his marital home.
- To borrow £220,000 to purchase a new property.
- Leave an inheritance to help his children onto the property ladder in the future.
Derek knows how hard it is for younger generations to get on the property ladder and is keen to leave a sizeable inheritance to his two grown up children. He has a comfortable salary and with his available equity and pension pot, wants to start afresh with his life.
Layla will receive an estimated £200,000 in exchange for Derek keeping his pension, savings, and car, whilst also keeping her existing pensions. Derek will receive approximately £110,000 which he will use to cover the deposit on a new home and moving fees.
table Assets Expected outgoings
House value £390,000
Outstanding mortgage £80,000
Defined benefit pension worth £20,000 per year, combined with state and defined contributions pensions is projected to be over £30,000 of gross pension income per year
Living expenses: £800 a month
Derek could use a Retirement Interest Only (RIO) Mortgage to purchase the new property. With a dependable income history, sufficient pensions, and no dependents as his children are grown up, he should pass the affordability test.
Under our current RIO Mortgage, Derek could borrow up to £142,500 (4.75 times his salary) against the property. This would cost him £485 per month1 and the interest rate would be fixed for life. However, he could afford repayments up to £875 per month whilst working, and up to £758 per month on pension benefits.
With our new loan to income (LTI) caps on a RIO Mortgage, Derek would be able to borrow the £220,000 he needs to purchase the new property, which would cost him £749 per month1.This is within his affordability constraints both before and after he retires.
Benefits for Derek
- He can borrow the amount he requires to purchase the new home closer to his children.
- The certainty of a fixed interest rate for life.
- His available income streams mean he can afford the repayments on a RIO and pass the affordability test.
- As Derek is keen to leave an inheritance, a RIO may suit him better than a Lifetime Mortgage as the inheritance will remain in the property.
- If Derek’s new house continues to grow in value, the inheritance could provide a deposit for both his children and help them onto the property ladder in the future.
What are the potential risks?
Your client should think carefully before securing other debts against their home. As a last resort, their home may be repossessed if they don't keep up repayments on their mortgage.
Their ability to make the payments may be affected if:
- Their income falls in the future.
- Their expenditure increases in the future.
- Inflation reduces the purchasing power of their income.
Taking out a mortgage in later life could limit their future choices too. For example:
- It might affect their family's inheritance when they die.
- They may not be able to afford any additional care needed in later life.
- Their future choices in moving home could be limited.
- Opportunities to borrow from other sources could be limited.
- If the loan is for life, they'll repay the loan from the proceeds of the sale of their home when the last borrower moves into long-term care or when they die.
1Based on an interest rate of 4.09% accurate as of 8 April 2022. Subject to change.