Pension mortgages can be tax effective for some

If falling stock market values have had a negative effect on endowment mortgage funds as well as on pension fund values, then should people with a pension mortgage - a veritable hybrid of the two - be worried about the long-term viability of their commitment?

There has never been as widespread a take-up of pension mortgages as there has been - at least up to about five years ago - of endowment mortgages. Pension mortgages are restricted mainly to the self-employed and directors and lenders do not publicly advertise them. They have traditionally been arranged on a once-off basis, usually through a financial adviser or accountant. Pension mortgages work this way: a loan is arranged with a lender, but instead of paying off both interest and capital as is done with an ordinary repayment or annuity mortgage, interest only is paid. (Interest only is also paid when you take out an endowment mortgage.)

Unlike an endowment, however, it is the pension fund rather than a life assurance policy which is used to pay off the capital loan at the maturity date. Since you are obliged to buy an annual annuity with the fund, it is specifically the tax-free lump sum (worth 25 per cent of the total pension fund) which is used to pay off the capital. The advantage of a pension mortgage is that not only can mortgage interest relief for the full term of the loan be claimed, but you also get pension contribution relief at the highest income tax rate. Also, pension funds are not taxed internally, the way ordinary life assurance investment funds (including endowments) are, resulting in better investment returns from pension funds. However, not every self-employed person is a suitable candidate for a pension mortgage. Most financial advisers believe the person should be a typical hinet worth earner in their early to mid-40s, with an established private business or practice that has steady future income growth potential. He or she should also have other assets - such as another property, stocks and shares or business assets.

This wider portfolio of assets is especially important in the event (however unlikely) that the Revenue Commissioners were to change the rules governing the use of the tax-free lump sum; in such a case, the pension mortgage holder would no longer be able to use it to pay off the loan. Nor is a pension mortgage a good idea for anyone with a low-risk threshold since equities - the main asset underpinning most pension funds - are by their very nature volatile. (This is also the strongest argument against ordinary PAYE earners taking out endowment mortgages.) Though it isn't essential, it makes sense to time the taking out of a pension mortgage with retirement, advisers say. If someone expects to draw down their pension at age 65, then a 20-year pension mortgage taken out at 45 will result in the capital being paid off in tandem with retirement. Any later, and it becomes even more crucial, if the house debt is to be paid off in time, that the pension is being correctly funded and the investment mix is just right.

Advisers say they are not particularly worried about the viability of pension mortgages in this climate of downturning stockmarkets. Most believe that anyone who takes one out in their 40s, who already has been contributing to a pension fund and has another 20 or 25 years of funding to go, is more than likely going to have an adequate final pension fund to cover any property repayment. In many cases, "the sort of people who take out pension mortgages usually clear them off through refinancing or with other assets before they retire anyway", we were told. Short-term stockmarket slides - or rises - are practically irrelevant for such a long-term investment, especially if the pension fund is not the only asset that can be called upon if there is a shortfall at the end of the mortgage term.