Rising interest rates, your mortgage and your pension

id

UK interest rates having been rising recently, so it’s natural for people to feel worried about the impact on their mortgage. But if you’re thinking about taking your pension savings earlier than planned to help pay off your mortgage, there are things to consider first. 

Why have interest rates gone up?

Interest rates have gone up due to the rising price of goods and services – in other words, due to high inflation.

When prices of goods and services rise, the Bank of England tends to increase interest rates. By doing so, they can help to bring inflation back down again. And this is important, as low and stable inflation makes for a healthier economy.

The Bank of England recently raised the UK’s key interest rate – often called the ‘base rate’ or ‘Bank Rate’ – to try to reduce inflation. This affects other interest rates in the UK and can influence different lenders. So other banks might offer mortgages at a similar rate to this, for example.

What rising interest rates mean for you

When interest rates rise, it becomes more expensive to borrow money. The higher the rate, the more money you need to pay back on the sum you’ve borrowed.  

On the flip side, high interest rates can mean that you earn more on any money you have in a savings account. So you might find your bank pays more into your savings account now than they did before.

Ultimately, though, we know this is a worrying time for some people. If you’re a homeowner, how these interest rates affect you will depend on the type of mortgage you have.

• Tracker mortgage – Your repayment costs will go up or down according to how the Bank of England decides to set the base rate. Your repayments will get more expensive whenever the base rate rises.
• Other variable-rate mortgages, like the standard variable-rate mortgage – Your repayments might be influenced by the base rate, but your lender essentially decides how much you pay. So your repayments might become more expensive when interest rates are high.
• Fixed-rate mortgage – No matter what interest rates look like, your repayments should stay the same until you reach the end of your fixed term. If interest rates are still high after that, you can expect your repayments to go up in cost.

Thinking about accessing your pension?

We’ve seen that more people have been dipping into their pension pots recently, likely because they need help with the cost of living. This might seem tempting if you’re facing higher mortgage costs, but it’s important not to rush into any big decisions. 

People can usually start taking their pension savings from the age of 55 (rising to 57 in 2028). Generally, there are different ways to take your pension money. For instance, if someone wants to pay off their mortgage with their pension savings, they might consider taking cash lump sums or even withdrawing all their money in one go. But accessing pension money to pay off a mortgage might not be the most suitable course of action for everyone, so taking a step back and thinking about the long term could be valuable.

What to consider before withdrawing money from your pension

You might not have enough money later

If you take money from your pension pot early, you might not have enough in the future. People are generally living longer nowadays and will likely need more money to cover their costs in the long run. If you take too much from your pension savings now, you might have to work for longer so you can make ends meet in retirement. You’d need to plan out how much you’re taking and feel confident your money will last. 

You could have some big tax bills

The first 25% of your pension pot is usually tax-free. But you’ll have to pay income tax on the remaining 75%. So if you withdraw a large lump sum, you could have a lot of income tax to pay. Sometimes large lump sums can be subject to emergency tax, and you’d have to spend time claiming this money back. 

If you start taking money out of your pension pot while you’re getting an income from elsewhere – for example, if you’re still working – you could also end up in a higher tax bracket.

It’s worth keeping these tax implications in mind if you’re considering using your pension savings to pay off your mortgage. If your outstanding mortgage balance is greater than your tax-free lump sum, you might want to think particularly hard about your decision. 

Bear in mind that tax rules are different in Scotland. Laws and tax rules may change in the future. Your own circumstances and where you live in the UK will also have an impact on tax treatment.

You may restrict future pension payments

Some people take cash from their pension pot but continue to save into it. But if you start taking a flexible income (sometimes known as drawdown) from your pension plan, you may have a lower allowance. In this case, when you start taking taxable income (anything over your 25% tax-free entitlement) from your plan, the Money Purchase Annual Allowance will apply. In other words, the amount you can pay into your plan while still getting tax benefits on your payments typically falls from £40,000 to £4,000. So if you put in more than £4,000 in a given tax year, there could be a tax charge. To learn more about this, you can visit our guide on the pension annual allowance. 

You could impact your state benefits

Taking money from your pension savings can affect your eligibility for certain state benefits, meaning you could find that some of your benefits stop. You can visit the Citizens Advice website to see which benefits may be impacted.

You might miss out on some growth

The longer you leave your money invested in your pension pot, the more opportunity it has to grow. If you keep your money in and your investments perform well, this could really give your savings a boost. But remember, a pension is an investment. Its value can go down as well as up and could be worth less than was paid in.

How to prepare for rising interesting rates

Here are some other actions you can consider taking if you’re worried about interest rates impacting your ability to pay your mortgage.

Try a mortgage calculator and set a budget

Online mortgage calculators can show you what your monthly repayments might look like at different interest rate levels. Having a ballpark figure in mind might ease some stress, as you have an idea of what costs you might be dealing with in future. Money Saving Expert has a free mortgage calculator you can use.

You could then set up a budget or adjust your existing one. A household budget can’t change the fact that the interest rates are high right now. However, it can help you to see if you’re overspending anywhere. You might spot new ways to cut costs, then you could put any savings you make towards your repayments. Our recent article explains the benefits of having a budget. 

Our support with everyday money worries page also offers tips to help you get on top of your finances and cut costs. This could help free up money to put towards your mortgage and give you some peace of mind. 

Consider using other savings

If you have money in an Individual Savings Account (ISA) or you have other savings, you might decide to put that money towards your mortgage. After all, many ISAs let you take your money tax-free. This could be a more suitable option than taking from your pension pot, since you’re less likely to wind up with a big tax bill. But do check the terms of whatever savings account you have. 

Do your research

Instead of paying off your mortgage with your pension money, you could explore other options. For example, you may wish to search for a different mortgage deal with cheaper repayments. However, it might not always be clear which deal is best for you, as the situation is so changeable at the moment. So if you’re hunting around for another deal, make sure you understand the pros and cons of different mortgage types. Which? can tell you about the different kinds of mortgages and what they involve.

Support and further information

The bottom line is, it’s important not to panic and make any drastic decisions in the short term without having all the facts. Doing your research can help you make decisions that suit you. 

Many people see their pension pot as something that can keep them financially afloat in later life. As we’ve described, taking your money earlier than you’d planned can have several knock-on effects. 

But everyone’s circumstances are different, and you may feel that accessing your pension money to pay off your mortgage is right for you. If this is the case and you’re over the age of 55, you can often start taking money from your pension pot. If you’re a Standard Life customer, you can usually do this online if you wish. To find out more about our online services, visit our website. You can go to our support page for FAQs and ways to get in touch. 

And if you want more help and support when it comes to your pension savings, you can visit Pension Wise. They offer free, impartial guidance for people over 50. 

The information in this article is based on our understanding in November 2022 and should not be regarded as financial advice. 

Standard Life accepts no responsibility for information on external websites. These are provided for general information.