How pension mortgages work

The example opposite shows how a buy-to-let investor can benefit from the tax efficiency of a pension mortgage. The illustration is based on a self-employed person aged 45 with an annual income of €70,000.

Tax relief on pension contributions is available on up to 25 per cent of income for people aged 40-49. The investor's contributions of €1,331 per month, stay within this maximum limit as their total annual pension contribution (€15,972) falls short of €17,500 (25 per cent of €70,000).

Because their capital is not decreasing, their interest payments are greater than if they had opted for a straightforward repayment mortgage. But this means that they benefit from higher mortgage interest relief.

On the pension mortgage, however, the investor will pay more in life insurance, which mortgage lenders require that investors take out. Life cover on pension mortgages is higher because it is based on the capital staying at the same level over the full term. On a repayment mortgage it is based on the outstanding mortgage decreasing as the loan is paid off.

In the example, the investor's pension mortgage has the same average net monthly cost as a normal repayment mortgage, based on an assumed average interest rate of 5 per cent.

The crucial difference is that in the end, an investor who opts for a pension mortgage is left with a €164,569 kitty that they can convert into pension income or stash in an Approved Retirement Fund (ARF). This figure is based on pension contributions growing at a rate of 6 per cent per annum.

Another way to structure a pension mortgage is to pay the minimum value of pension contributions estimated as necessary to clear the mortgage.

In the case of a €250,000 mortgage over 20 years, this would give the investor monthly savings of about €200 over a typical repayment mortgage.

But, on retirement, they won't have anything left to put into an ARF - their retirement income will be entirely confined to the selling price of the property.

Also, the investor runs the risk of there being a shortfall: if the actual investment growth is less than the assumed rate, the person may have to use part of the proceeds from the sale of the property to pay off the balance.