Savings & Investing

Saving for the future through buying a home

Apr 19, 2016

The two largest financial commitments most people ever make are buying a home and saving for retirement. Unfortunately, many people—especially younger workers—believe that these endeavours are in conflict. Faced with what they consider to be an either/or decision, many younger workers prefer to save for a down payment on a home and put off saving for retirement, thus missing out on the compounding effect of early, long-term investing.

A solution

Allow first-time home buyers to borrow from their retirement savings to raise money toward purchasing a property. The loan could be made by the pension in favour of the member and secured by a 2nd-ranking charge (a secured loan using the home as collateral) on the property.

This proposal could create two main benefits. First, it could bridge the gap between the price of the property and the amount that a first-time buyer could afford to borrow. Allowing people to access their pensions to fund their first house deposit is likely to go a long way to help address the crisis faced by first-time buyers who are being priced out of the market. Second, it might raise the appeal of pension contributions amongst younger people reluctant to put away money for their retirement when they can't yet afford to purchase their first home. Allowing people to access their pre-tax pension contributions to purchase a property could make the idea of making pension contributions in the first place more appealing to younger people. It could also engender a culture of investing, rather than simple bank saving, at an early age.

Conditions / assumptions: For ease and simplicity, assume that a fixed rate of interest applies—e.g., 2.5%—and that this is permitted to roll up. Incentives could be built in for people to repay the loan early as possible (perhaps apply a higher interest rate after a period of time, say 10 years). In any event, the outstanding balance would become due and payable upon the sale of the property, which would happen when the person is ready to move and upgrade.

Example: Kate wants to purchase her first property, an apartment worth £180,000 (including stamp duty). She is a teacher with ten years’ experience, earning a salary of £35,000. Her bank will lend her £140,000 (4x salary) and she has ISA savings worth £10,000, leaving her a £30,000 shortfall. She happens to have £30,000 in her workplace pension scheme. What if she could access her £30,000 pension savings to complete the property purchase?

Mechanics:

  1. Kate instructs her pension manager to convert her £30,000 pension assets into cash.
  2. Her pension makes an interest bearing loan to Kate for £30,000. The plan would be structured so that no tax implications would arise.
  3. Kate uses the £30,000, alongside her £10,000 ISA savings, as a deposit to secure her mortgage and purchase her property.
  4. As security for the loan, the pension scheme takes a 2nd-ranking charge on the property; the loan now forms part of the Kate's pension assets (similar to a bond or other debt obligation).
  5. Interest accrues on the loan at a set rate (e.g., 2.5% per year). This would roll up and Kate could pay this down as she can afford to do so.
  6. Upon eventual sale of the property, any remaining balance on the mortgage and loan would be repaid in full.

For the first-time buyer:

Pros

  1. Enables her to get on the property ladder sooner, saving years of rental costs.
  2. Enables her to afford a higher value property that is potentially more suitable for long-term needs.
  3. Enables access to a mortgage with a lower loan-to-value ratio, which should lead to a lower interest rate and therefore lower interest 'leakages.'

Cons

  1. Jeopardises the ability to use retirement savings for non-property related needs, e.g. if a borrower can't keep up with mortgage payments.

For the pension:

Pros

  1. The loan would be an interest-bearing obligation, secured by a 2nd-ranking charge over the property. The value of the security could improve over time as the individual repays their mortgage.
  2. The loan would be a new type of asset uncorrelated with security markets.

Cons

  1. 2nd-ranking charge is weak compared to the 1st-ranking mortgage holder.
  2. Could see delays in payments on the loan if there are no immediate impacts for non-payment.
  3. In the short-term, pension savings would not be diversified.

Impacts on public finances:

  1. Compared to other government initiatives for first-time buyers—e.g., help-to-buy scheme and help-to-buy ISA—this proposal does not involve any form of direct cost or subsidy
  2. This proposal will likely encourage people to save into their pension, which is likely to have a marginal impact on tax collections.
  3. In the UK, Her Majesty’s Treasury would be likely to see an increase in stamp duty collections.
  4. However, a change in law would be required to allow pensions to be used in this way.

Finally, this proposal differs substantially from existing schemes around the world. In Australia, one can invest pension funds in investment property but not in a personal residence. In New Zealand, one can obtain a grant from KiwiSaver, which is non repayable. In Singapore there is a similar scheme but it is not limited to the first time buyer.

David J. Blumer
Head of Europe, Middle East & Africa
David Blumer is a member of both the Global Executive Committee and the Global Operating Committee at BlackRock. Prior to joining BlackRock in 2013, he was ...