Following on from our blog in relation to lenders assessing affordability in the mortgage market, this blog explores the conduct risk challenges within the mortgage market due to the rise in Lending Into Retirement (LIR). There are several factors that have contributed to LIR growth which are detailed below (non-exhaustive):
- An ageing population as well as rising house prices means that larger deposits, loan values and increased terms are required, as a result consumers are buying their first property at an older age than previous generations;
- The maturity of legacy interest only mortgages for customers that do not have a suitable repayment vehicle;
- Parents wishing to release equity in later life to support children or grandchildren with house deposits or where customers may have a shortfall in retirement income; and
- A relaxation in lending criteria (for instance, increased maximum age, increased mortgage terms and increased loan to income ratios) in an attempt to cater for the increased demand for LIR and to compete within this growing segment of the mortgage market.
These factors have led to UK Finance recently commenting that during 2021 more than 50% of new homeowner loans were due to end after the main borrowers 65th birthday. This will lead to an increase in the number of customers working into later life and an expectation that the volume of customers borrowing into later life will continue to increase as well. This area is likely to receive increased regulatory attention as lenders continue to relax their criteria and lending into retirement grows. This blog explores the key areas of focus that firms need to consider when lending into retirement.
Assessing affordability into retirement
We observe a significant move towards increasing the maximum age criteria to meet the growing demands of customers with later life lending requirements. This has created additional complexities within underwriting processes as a customer may be more likely to experience a significant change in their income during the life of the loan (due to retirement), die during the term of the mortgage, or in the case of an interest only loan, be required to sell and downsize their property at an older age. The three main considerations that we believe lenders need to focus upon within their retirement affordability assessments are:
- Assessing retirement income
- Sole survivor and vulnerability risks
- Retirement ages.
Assessing retirement income
The assessment of retirement income is a relatively straightforward task for those that have guaranteed pension benefits such as a state pension, final salary pension or have purchased an annuity. There has however been a clear shift within the private sector pension marketplace from traditional defined benefit (final salary) schemes to defined contributions schemes which means that some elements of a customer’s income may no longer be guaranteed in retirement and are subject to market conditions in the lead up to retirement and during retirement unless the consumer chooses to purchase a guaranteed income during retirement through an annuity. This means more and more customers need to carefully manage the drawdown of income and the decumulation of their other assets in retirement to ensure their pension pots do not run out. This can make assessing affordability more challenging, with affordability calculated on more volatile incomes sources that have not been appropriately scrutinised or understood to determine whether this income is sustainable and appropriate to use to assess affordability. In these instances, there a greater level of due diligence is needed to verify and scrutinise the sustainability of this income. With LIR becoming increasingly common based on UK Finance data, lenders need to ensure their underwriters are equipped with tools to calculate realistic and sustainable levels of income for these types of customers in retirement.
Sole survivor and vulnerability risks
The FCA introduced the definition of a retirement interest only mortgage in 2018 as a response to the growing demand for later life lending. This led to the introduction of the retirement interest only mortgage in which consumers make monthly interest repayments until the death or entry into care of the final party to the mortgage. This creates the risk that where there are two parties named on the mortgage that one party has to continue to repay the mortgage upon the death or entry into care of the other party which may create affordability issues. This issue also exists for those mortgages which would not fall under the retirement interest only classification for lenders that have significantly increased the maximum lending age within their interest only criteria or for capital and interest mortgages that extend further into later life. Whilst there is clear guidance within Mortgage and Home Finance: Conduct of Business Sourcebook (MCOB) in relation to assessing affordability for retirement interest only mortgages on a sole survivor basis, these rules do not extend to Interest Only and/or Capital and Interest mortgages which extend into retirement and beyond the average life expectancy of a consumer in the UK based on ONS statistics. A key risk is that lenders do not have adequate controls in place to assess this risk within their underwriting practices. This means that lenders may have a residual portfolio of consumers borrowing into later life where it is not known whether they will be able to continue to meet the mortgage repayments following the death of one party. This may result in consumers entering collections or recoveries in old age or having to downsize their properties in much later life when they may be considered more vulnerable. This could also lead to a scenario of a customer having their property repossessed in old age and being forced to find alternative accommodation.
More customers are borrowing into retirement alongside whilst declaring that they expect to work into their 70s on their applications. Whilst the state retirement age is scheduled to increase to 67 from 2028 and the majority of lenders use the age of 70 as a baseline for retirement, we have seen some customers declaring that they expect to work until the age of 80. The feasibility of this however is largely dependent on health factors and may not be realistic, especially in more manual roles. Furthermore, we are aware that some firms have taken steps to consider the feasibility of customers carrying out their stated profession into later life where this may be considered unrealistic, such as a surgeon or builder working until the age of 75, to ensure that an assessment of retirement income is undertaken, where appropriate. This degree of challenge is important as the majority of customers will experience a reduction in their income upon retirement and may struggle to meet the ongoing mortgage repayments if this is not assessed appropriately at the outset of a mortgage application.
Firms should consider the following as part of their retirement affordability assessments:
- How do you ensure that you are appropriately assessing the sustainability of income in retirement following the shift in the marketplace from defined benefit to defined contribution pension schemes and that there are clear assumptions in place to calculate pension income as part of any income drawdown from pension schemes and that the longevity risk is adequately understood?
- In what circumstances should a lender assess sole survivor affordability?
- What is considered a reasonable age for a customer to be asked to sell and downsize their property?
- What is considered a reasonable retirement age and how feasible are customer’s retirement ages?