Article by Yoram Lustig
In the last of three articles in which we explore three ways to save and invest for retirement, we turn our attention to residential property.
We all need a place to live before and after retirement. One way to save for retirement is buying your home. This is a large financial commitment, normally requiring borrowing money from a bank through a mortgage.
A mortgage is a loan secured on your property. If you do not repay your mortgage, the bank might repossess your house. That is a risk for you. However, because your home is a good security for the bank, it normally charges a lower interest rate on the mortgage compared to those it charges on unsecured loans.
As the years go by and you gradually repay your mortgage (assuming it is a capital repayment mortgage), you increase your equity or ownership in your property. Eventually, when fully repaying the mortgage you own the home outright. Repaying a mortgage is therefore a form of saving.
Owning your house has a number of benefits, beyond a roof over your head. You enjoy home improvements; property may appreciate in value over the years; and when you retire you can release some equity. You can downsize (selling an expensive house and moving to a cheaper one) or buy equity release products from an insurance company. Such products might pay you a lump sum or income in exchange for your house, but letting you to live in it for the rest of your life.
Another way to tap the residential property market for long-term saving, is buying a property to let or buy-to-let. This is not suitable for everyone since it is expensive and demanding. However, buying a property with mortgage financing, letting it and aiming for the rent to pay the mortgage payments may enable you to end up owning a property after retirement. Tax-free lump sum from your pension can reduce the mortgage.
Buy-to-let could generate rental income, perhaps complementing your pension. One advantage is that this rent differs from other streams of income, such as annuities and investments in financial markets, helping to diversify your income sources. Another advantage is that property is bricks and mortar – it cannot go bankrupt like a bank or an insurance company.
The disadvantages are that it might be expensive (unexpected maintenance costs); voids might be long; property is illiquid as it is costly to sell; and you are a landlord. This means having to deal with tenants, who might be difficult. So buy-to-let needs a commitment.
Owning your home, having diversified sources of income from your State Pension, annuity and flexible drawdown, rental income from buy-to-let and savings in ISAs can help you achieve a financially secured retirement. It is challenging since it requires careful planning, discipline to stick to your plan and a bit of luck. However, planning and saving for your retirement is probably one of the most important activities you need to do for yourself and your loved ones. So take it seriously and act today.
Part 1: ISAs
Yoram Lustig is the author of the new Financial Times Guide: Saving and Investing for Retirement. It is out now, priced £26.99 from FT Publishing, and available from Amazon