SNAPSHOT2 min read

How to manage increased mortgage costs without reducing pension contributions

23% or people said they would reduce pension contributions to cover increased mortgage costs. Read about why this may not be a sensible choice.

31/08/2023
Benchmark customer focused

In April 2021, the average price of a pint of milk, according to the Office for National Statistics [1] (ONS), was 42p. By April 2023, it had risen to 68p.

You have likely seen headlines about high levels of inflation and the rising cost of essential goods and services such as food or fuel. And you may have noticed the effect it has on your monthly outgoings too.

However, the growing cost of food and fuel may not be your biggest concern, as high inflation is also causing interest rates to rise. This could mean that you face increased mortgage repayments in the near future, if your payment has not already gone up.

Over 1 million households could pay an extra £500 a month by 2026

Inflation has been above the Bank of England's (BoE) 2% annual target for more than two years now, with the latest figures from the ONS [2] showing that inflation was 7.9% in the 12 months to June 2023.

In response, the BoE has put measures in place to control inflation and try to bring it down to the target.

Increasing interest rates is one of the main ways the BoE does this because banks, building societies, and other financial institutions tend to follow suit and increase their rates, making borrowing more expensive. It also boosts the interest rates on savings accounts, so consumers may be more likely to hold onto their cash instead of spending it.

This can reduce demand for goods and potentially slows down price rises, ultimately reducing the rate of inflation.

As such, the BoE [3] has raised its base rate 14 consecutive times since 2021, reaching 5.25% on 3 August 2023. Meanwhile, mortgage rates have been increasing alongside it.

Indeed, according to Rightmove [4], the average interest rate on a two-year fixed mortgage with a 95% loan-to-value (LTV) ratio was 6.94% on 31 July 2023.

This is a significant increase from the average two-year fixed mortgage interest rate of 1.99% reported by Moneyfacts [5] in July 2020.

As their fixed-rate mortgage deals come to an end, people across the country could see a significant jump in their monthly payments. In fact, as the Guardian [6] reports, over 1 million households could pay an extra £500 a month by 2026.

Consequently, you may need to find room in your budget to account for increased mortgage costs.

23% of people said they would reduce pension contributions to pay increased mortgage costs

A survey reported by Mortgage Solutions [7] found that 23% of those questioned, with assets of £250,000 or more, said they would reduce their pension contributions to deal with higher mortgage costs.

While this may help you manage a higher monthly mortgage payment, you could be missing out on crucial compound returns on your pension savings. Most importantly, you may not be able to make up for the missed contributions later in life, so you could end up with a smaller retirement fund.

Stopping pension contributions for a year could mean up to £13,000 less in your retirement fund

You may think that stopping or reducing your contributions for a short time will not make a big difference to your pension in the long term.

However, a study from Standard Life [8] suggests that it could significantly impact your quality of life in retirement.

Their figures show that stopping pension contributions for a year at age 35, if you started contributing when you were 22, could leave you with almost £13,000 less in your retirement fund when you are 68.

Considering nobody can predict how long interest rates may stay at current levels, you could end up stopping contributions for longer than a year if you adopt this strategy.

The following table shows what the effects of this could be on your pension, if you started contributing at age 22 with a salary of £25,000 and the minimum contributions required by auto-enrolment – 3% employee and 5% employer contributions:

How pausing pension contributions could affect your total retirement savings

Length of time that pension contributions are stopped for

No breaks or reductions in contributions

Stopping contributions for one year at the age of 35

Stopping contributions for two years at the age of 35

Stopping contributions for three years at the age of 35

Total retirement fund at age 68

£456,893

£444,129

£431,558

£419,180

Potential loss in savings

£0

-£12,764

-£25,335

-£37,713

Source: Standard Life [9]

So, as you can see, stopping or reducing pension contributions could harm your financial plan in the long term.

Fortunately, there are alternative ways to manage those additional costs without disrupting your retirement plan.

5 ways to deal with increased mortgage costs without reducing your pension contributions

1. Speak to your lender as soon as possible

If you are concerned about rising mortgage costs, you may want to speak to your lender as soon as possible. In many cases, they will work with you to make the payments more manageable.

For example, they may be able to offer a payment holiday or a temporary reduction so you can continue making your monthly payments.

It is important that you do this as early as possible, so you can come to an arrangement with your lender. Otherwise, if you miss payments or do not pay in full, and this is not agreed with your lender, it could negatively affect your credit score.

2. Switch to a better deal

Many people face increased monthly costs when their current fixed-rate mortgage comes to an end, as lenders typically move them onto their standard variable rate (SVR), which tends to be higher.

Indeed, the average SVR is currently 8.49% according to Uswitch [10], which is significantly higher than the average fixed-rate mortgage interest rate.

So, if you are no longer on a fixed-rate mortgage, or yours is coming to an end soon, you may want to consider switching to secure a lower interest rate.

Even though current rates are comparably high, you may be able to find a cheaper option, especially if you are paying the SVR.

3. Consider switching to interest-only

If moving to a better deal is not an option, you may want to talk to your lender about switching to an interest-only mortgage.

This can bring your monthly payments down as you only pay the interest and not the principal amount of the loan.

For example, the monthly payment on a property worth £286,000 – the average UK house price in July 2023 according to the ONS [11] – with an LTV ratio of 90% and an interest rate of 6% would be £1,824.47 (figures from MoneyHelper [12] mortgage calculator).

Meanwhile, if you switched to interest only, your monthly payment would drop to £1,415.70.

However, bear in mind that you are not reducing the debt itself, and you will need to continue paying in full in the future or repay the loan when you sell the home.

4. Extend the term of your mortgage

Extending the term of your mortgage can reduce the monthly payments because you pay the loan back over a longer period.

Using the same example as above, your monthly mortgage payment would be £1,824.47 with a term of 25 years. If you increase the term to 40 years, the monthly payment drops to £1,557.87.

However, you may not be able to do this if you have a fixed-rate mortgage, and it is important to consider how this will affect the overall amount of interest that you pay.

The interest on the loan remains the same, but you pay this for an additional period of time, so the overall cost is significantly higher.

5. Speak to a mortgage broker

Deciding the best course of action can be challenging as there are pros and cons to each option here. Before making any changes, it is important to consider not only how it affects your monthly mortgage payment, but how it could affect your long-term goals.

As such, it may be a good idea to speak to a mortgage broker who can help you manage increased mortgage costs. They may also have access to deals that are not generally available to the public.

Get in touch

If you are concerned about increased mortgage costs, we can help you find ways to manage them without disrupting your long-term financial plan.

Please visit our contact page or speak to your adviser.

Please note

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.

Buy-to-let (pure) and commercial mortgages are not regulated by the FCA.

Think carefully before securing other debts against your home.

[1] 03.08.2023 Ave. price – milk: pasteurised, per pint Office for National Statistics

[2] 03.08.2023 Consumer price inflation, June 2023 Office for National Statistics

[3] 03.08.2023 Official Bank Rate history Bank of England

[4] 03.08.2023 What are the current UK mortgage rates? Rightmove

[5] 03.08.2023 2020 mortgage interest rates review Moneyfacts

[6] 03.08.2023 Mortgages to cost 1m borrowers extra £500 a month by 2026, Bank warns the Guardian

[7] 03.08.2023 Homeowners cut pension contributions to pay rising mortgage bills Mortgage Solutions

[8] 03.08.2023 Standard Life highlights the long-term implications of pausing pension contributions during the cost of living crisis Standard Life

[9] 03.08.2023 Standard Life highlights the long-term implications of pausing pension contributions during the cost of living crisis Standard Life

[10] 03.08.2023 Compare mortgages Uswitch

[11] 03.08.2023 UK house price index May 2023 Office for National Statistics

[12] 03.08.2023 Mortgage calculator MoneyHelper

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Benchmark Financial Planning is an Appointed Representative of Best Practice IFA Group Limited which is authorised and regulated by the Financial Conduct Authority, the registration number is 223112. Registered office: Broadlands Business Campus, Langhurst Wood Road, Horsham, West Sussex, RH12 4QP. Registered in England and Wales No 07572431.

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