Borrowers are looking to trim outgoings, but stopping pension contributions could have dire consequences for your financial wellbeing in retirement. Rachel Lacey explains why and what you could do instead.
If spiralling food prices and soaring energy bills weren’t bad enough, more homeowners are facing up to the prospect of massive hikes to their mortgage repayments over the coming months.
Although interest rates have now increased 12 consecutive times – reaching an almost 15-year high of 4.5% this month – many homeowners have yet to feel the pain of higher mortgage repayments because they are still on fixed-rate deals.
The popularity of fixed-rate mortgages in recent years has halted the impact of rising interest rates for many borrowers – with £9 in every £10 lent on mortgages done so on a fixed rate basis last year, up from just £4 before the financial crisis, according to the Resolution Foundation.
As a result, the think tank estimates that as many as half of the UK’s 7.5 million mortgaged households are yet to feel the pain of rising mortgage repayments since interest rates started climbing in December 2021.
But between the start of 2023 and the end of 2024 around 1.6 million households will come to the end of their current fixed rate and need to remortgage.
And even by switching to a new mortgage – to avoid paying costly standard variable rates – the Resolution Foundation has predicted the average homeowner will see their mortgage repayments soar by an average of £2,300 a year.
The hikes will be even greater for those with larger mortgages, who after years of enjoying rates fixed below 2%, may now have to pay north of 4%.
Take the example of a borrower with a £300,000 mortgage on a 25-year term, who is coming off a rate of 1.99% now, and switching to a new two-year fix at 4.39%. According to figures from mortgage broker, Trinity Financial, monthly repayments would rise from £1,270 to £1,632 – an extra £362 to find every month.
Even though the Bank of England has suggested that this intense period of interest rate rises should be drawing to a close, the Resolution Foundation has said market prices for new mortgage deals suggest that interest rates are not likely to fall nearly as quickly as they have risen. Mortgage rates, it says, are likely to remain above 4% until the end of 2026.
That means borrowers aren’t just facing higher mortgage rates for a brief duration. Homeowners, who may already be struggling with higher living costs, will need to come up with a longer-term plan for bigger mortgage bills.
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Extending the mortgage term could provide borrowers with some financial breathing space.
Take our borrower, who has just switched onto a new two-year fix. If they were able to extend the term by five years to 30, repayments would fall from £1,632 to £1,483, but it only saves £149 a month.
Extending a mortgage term also means homeowners will pay more interest overall and – depending on their age - may even struggle to stretch their loan out if it means it will run into their retirement.
Pension contributions are easy target
It’s not surprising then that many borrowers will be looking for expenses that are easier to cut.
According to research from Access People, Google searches for opting out of workplace pensions have increased by 36% over the last year.
Similarly, research from the Pensions Management Institute at the end of last year revealed that 7% had already stopped making pension contributions during 2022 as result of rising costs; 13% had reduced contributions and a further 20% were contemplating doing so.
Three-quarters of the working people surveyed also said that the cost-of-living crisis meant they would be less well off in retirement.
But while pension contributions might be an easy expense to slice, without inflicting any pain in the short term, it could have dire consequences for your financial wellbeing in retirement.
Even cancelling or scrapping pension contributions for a short-period (until interest rates fall or you find other sources of income) could make a serious dent to your pension.
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Alice Guy, head of pensions at interactive investor, points out that a 35-year-old who reduced (or cancelled) their pension contributions by £362 (the size of our borrower’s repayment hike) for just one year, would lose £19,854 by the time they turned 66 (assuming 5% a year investment growth).
That’s because you aren’t just missing out on the value of your monthly pension contribution, you’re also losing the investment growth and compounded returns that money achieves over – in this case – the next three decades.
Cutting other long-term investments to make up a mortgage payment shortfall – such as ISAs – could also result in similar losses.
Alice Guy says: "The issue is that years of ultra-low interest rates have inflated house prices, meaning many of us have to take on eye-watering levels of debt just to afford a family home. Now interest rates are rising it’s going to be a tough time for many families with the double whammy of a big mortgage and rising rates.”
This means rather than cutting back on pensions or investments, borrowers should, wherever possible, stick to traditional budgeting to try and free up the money – even if it does feel like the more painful option right now.
Guy adds: "If you can afford to make cuts elsewhere it's worth trying to keep up pension payments as well as mortgage payments. The long-term nature of investment means that missing out on pension contributions, especially with added tax relief and employer contributions, can put a significant dent in your retirement savings."
With budgets already under pressure, that may well be a squeeze, so it’s worth looking at ways you can potentially make money too. This could be anything from renting out your garage or spare space on your drive through apps like Just Park, or renting out a room to a lodger. It might not have been an option you’d considered before, but if you have the space and would enjoy opening up your home, it can be a very easy way to make a bit of extra tax-free cash (you can earn up to £7,500 tax free through the Rent a Room scheme). Many lodgers today only require a room Monday to Friday too, so it might not be as intrusive as you’d initially think.
If reducing contributions into pensions or ISAs is your only option, there are ways to reduce the impact and make your existing capital work harder:
- Consolidate old pensions you’re no longer contributing to into a SIPP to reduce running costs
- Check performance of actively managed funds and switch to cheaper trackers if they aren’t beating the index
- Review your risk profile and consider some higher risk investments if you have a lengthy investment horizon
- Check the charges on your pension and stocks and shares ISAs to ensure you aren’t paying more than you need. Using a platform that charges a flat fee means your costs don’t rise as your portfolio grows
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