Categories
Are Retirement Interest Only RIO Mortgages a Good Idea
Retirement Interest-Only (or RIO) mortgages provide a way for those in their retirement to purchase new property or use the equity in an existing home for other uses - but are they really a good idea or best to be avoided?
At Clifton Private Finance, we dig deep to find out the real story behind RIO mortgages.
Are Retirement Interest Only RIO Mortgages a Good Idea?
They are legitimate and regulated product designed to help retirees release money from their homes in later life, and offer a financial solution where few other funding options exist.
Like any loan, they come with costs - mainly in the form of interest.
However, the notable difference between RIO mortgages and other equity release products, such as lifetime mortgages, is that you pay the interest on your loan monthly.
This means your outstanding capital amount remains the same throughout the mortgage term. The advantage here is that the outstanding interest doesn't compound and grow over the years - you simply clear it each month and repay your original loan value when you pass away or move into long-term care - usually by selling your property.
So, the advantage is that your mortgage doesn't grow exponentially over the years, but the disadvantage is that you have a monthly commitment to keep up with in the form of interest repayments.
Let's break it down in more detail.
And to speak to an adviser about whether it's a good idea for your situation, you can book a consultation with one of our team below.
Contents
What is a RIO Mortgage and Why Do They Exist?
What Can You Do With a RIO Mortgage?
Crunching the Numbers - Is a RIO Mortgage a Good Idea?
The Conclusion
What is a RIO Mortgage and Why Do They Exist?
Getting a mortgage once you have retired is very difficult. Lenders are keen that the mortgage is repaid without any problems, and there are two things working against retirees looking for a mortgage: your age, and your income.
Mortgages are a long-term commitment, and mortgage lenders are still looking for you to be receiving a decent income for that entire time.
When you’re not working, it’s hard to convince anyone that’s the case and, without wanting to be morbid, you also need to convince them you’ll be alive to see the mortgage to the end.
A RIO mortgage is a hybrid product that falls between a standard interest-only mortgage, often used for buy-to-let, and a lifetime mortgage, developed for equity release.
It uses aspects of both products to offset the disadvantages of the other, and essentially solves two 'mortgage problems' for retirees:
Problem 1: Interest-Only Mortgages Have a Set Term
A standard interest-only mortgage has a set term, after which time you are required to pay off the capital - and a set term is something which banks and other mortgage lenders don’t like to offer retirees.
To compensate for this, a RIO mortgage uses the ‘when you are no longer resident’ aspect of a lifetime mortgage rather than 'a number of years'; meaning that instead of a set amount of years, the balance of the mortgage capital is due upon your passing or if you enter full-time care.
Problem 2: Lifetime Mortgages Build Interest on Interest
One of the biggest problems and scare factors with a lifetime mortgage is the idea of the compounded interest.
Each month, a lifetime mortgage accrues interest, and each month that interest becomes a little larger as you pay interest on previously added interest. It can feel as if it is ballooning.
Even with helpful options such as the no negative equity guarantee, homeowners worry about the size of the interest portion of a lifetime mortgage and how it is going to cut a chunk out of their heirs’ inheritance.
What Can You Do With a RIO Mortgage?
A RIO mortgage has many uses, including:
- Cash to use for home improvements.
- Money to help family members, such as to help a grandchild through university, or provide a deposit for a child’s own house purchase.
- Making retirement more comfortable, with a lump sum in the bank that can be drawn on when needed.
- Going on a ‘once in a lifetime’ holiday, using the money you’ve put into the house to give you an otherwise unreachable opportunity.
- Purchasing a new property in retirement, perhaps as a holiday home or to move closer to family.
- Replacing an existing interest-only mortgage to avoid an end-of-mortgage home sale.
- Buying another sizeable purchase, such as a car or caravan.
- Consolidating other debts.
For more information on a RIO mortgage and how it can be used, along with some clear examples, read our detailed explanation of retirement interest-only mortgages.
Crunching the Numbers - Is a RIO Mortgage a Good Idea?
It’s all very well knowing the idea behind a RIO mortgage, but is it actually a good idea, and is it the right thing for you and your family? Let’s take a look at how it all pans out in reality.
Thought One - It’s My Money, I Should Be Able to Use It
One of the clearest arguments for any home equity release product, of which the RIO mortgage is one, is that it is your money and why shouldn’t you use it?
For years, probably most of your working life, you have been ploughing money into the home, working hard to pay the mortgage and provide a roof for the family. Now, here’s an opportunity to get some of that money back and use it for yourself.
If you have no children, or if they are doing well for themselves and don’t need your help, then this argument is particularly valid - after all, releasing the equity in your home effectively harms no one.
So, in this particular example, a RIO mortgage may not be the right product.
If you’re looking to release the equity in your home for yourself and any potential heirs are doing fine, then actually a standard lifetime mortgage may a better idea. It will provide a similar amount of usable cash, but you won’t have to make any repayments at all.
Thought Two - Releasing Equity with Minimal Impact
Those who are considering a RIO mortgage are often doing so because they want to impact the end estate value as little as possible.
Other equity release options - such as a lifetime mortgage, HELOC, or home reversion plan - all put significant pressure on the estate, releasing the equity in the property at a cost.
Let’s face it; a loan comes with interest, and at some point, that has to be paid. The way a RIO mortgage works, however, makes the interest as low as possible. Let’s look at some very simplified numbers to illustrate:
Imagine a RIO mortgage for £100,000 at 5%. Each year, £5,000 is accrued in interest (5% of £100,000), and divided up between the months, that’s £416.67 per month (£5,000 divided by 12). Assuming you live for fifteen years following taking out the Rio, you’ll pay £75,000 in interest; £416.67 per month for fifteen years.
But at the end, your estate only has to pay back £100,000. The total cost of the mortgage is £75,000.
Let’s compare that to a lifetime mortgage with exactly the same figures. You release £100,000 in equity at 5%, but now the interest is compounded. In the first month, interest is £416.46 - exactly the same as with the RIO, but in the second month, it’s £418.40. That extra £1.94 is interest on the previous month’s interest. And so it grows.
In fact, in the first year £5,116.19 will be added on in interest, £116.19 more than with the RIO.
Also, because we’ve moved the onus of paying the interest from yourself (in the case of the RIO) to the estate. The actual amount the estate must repay the bank is £211,370.39. From the perspective of any heirs, the difference between the RIO mortgage and the lifetime mortgage is more than a hundred thousand pounds of inheritance.
Clearly, in the pure financial interest of your beneficiaries, a RIO mortgage could be considerably better than a lifetime mortgage.
Thought Three - Isn’t It Just the Lender Profiting?
Yes, it is exactly that.
The truth is, banks and other mortgage lenders are businesses that are there to make money - that’s their entire purpose for existing. If they don’t make money, they fold and they stop existing and no one can borrow money from them.
The lender is providing you a service, and they’re asking for some money in the end for that service. They’re not making you do it, and they’re not hiding the calculations behind it; it’s your choice, and importantly, it’s your informed choice.
The lender profits because the lender is giving you something you otherwise don’t have - in the example we’ve just gone through, they’ve given you £100,000.
What the RIO mortgage does is minimise that cost. By making the regular repayments back to the bank, you are making sure that the amount the lender profits is as little as possible, paying some back now to benefit the future.
Thought Four - What if I Can’t Keep Up With Repayments?
Part of the RIO mortgage is, of course, the fact that you must make repayments every month. Just like any other mortgage, your home is at risk of repossession if you do not keep up with this financial commitment.
What does that mean if some years down the line it becomes too much for you and you’re struggling making repayments on a RIO mortgage? Will you lose your house?
One of the little-considered advantages of a RIO mortgage is its ability to be converted fairly easily into a lifetime mortgage. This means that if the repayments become difficult, you should immediately speak to your mortgage advisor or lender and ask about moving from a RIO mortgage to a standard lifetime mortgage.
Of course, you’ll lose some of the advantages the RIO mortgage has over a lifetime mortgage, but that’s a lot better than losing your home.
Thought Five - I Want to Buy A Property
Whether you are looking to move closer to family, get that dream cottage in the countryside, or get a holiday home, a RIO mortgage is able to accomplish that where a lifetime mortgage simply will not.
If you are aiming to use the money in your home to offset the purchase of a new property in retirement, then a RIO mortgage may be a good option.
Thought Six - What About My Spouse?
If you are joint homeowners, then the RIO mortgage will be something you take out together, and the responsibility for making the monthly interest payments will be with both of you.
That means that if one of you passes away or moves into residential care, the mortgage is still in place - only when the last remaining homeowner leaves the property does payment of the capital become due.
Also, if your spouse cannot make the repayments alone, they will be able to make use of the option to convert the RIO mortgage to a standard lifetime mortgage.
The Conclusion
We’ve taken a deep look at the RIO mortgage, but what’s the outcome? As with any financial product, a lot depends on your circumstances. In the case of a RIO if you are:
- Over 55
- Retired
- Still receiving a comfortable income
- Looking to purchase a property or make use of equity in your home
- Wanting to keep the interest burden on your estate as low as possible
- Understanding of the full implications of a RIO mortgage and how the lender makes their money
Then yes, a RIO mortgage may be a good idea.
Contact Clifton Private Finance today to discuss RIO mortgages with one of our specialist partners.
They can take you through the product in full detail, advise you on the current interest rates and range of options available, and help you get the very best deal by comparing the products from the wide selection of lenders in the UK mortgage marketplace.
We’re here to help.
