The quiet mortgage changes impacting financial planning

Danby Bloch white

There are some big changes being made to one particular social security benefit that could effect thousands of people: support for mortgage interest.

It is important advisers consider this in their financial planning for clients. The changes were announced in July’s Budget but received relatively little publicity despite their momentous implications.

Currently, SMI is paid if you are unable to make mortgage payments because of illness or a period of unemployment. Once upon at time, they were extremely generous. Indeed, in one notorious case that received much press coverage at the time, a former insurance company executive received payments representing the interest on thousands of pounds’ worth of mortgage. Nowadays there are limits and they are due to get rather more stringent.

SMI is a key state benefit for homeowners with mortgages who run into financial difficulty. Individuals qualify for it if they have a mortgage on their main residence and are receiving certain income-related state welfare benefits. In other words, it is means tested.

Under the current SMI rules, the state will pay the interest on a mortgage for someone who has met the criteria for eligibility after 13 weeks have elapsed. The amount payable is currently 3.12 per cent on loans up to £200,000 – not the actual amount of interest the borrower is paying. This statutory rate of interest was reduced from 3.63 per cent in July this year. This reduction was based on the Bank of England average mortgage rate. It moves automatically once that rate has changed by more than 0.5 per cent, which happened in April.

The capital repayments on the mortgage remain the individual’s responsibility and the homeowner also has to pay any interest the lender charges above this set rate. The benefit is usually paid direct to the lender and is not time-limited. The exception to its open-ended nature is where the claimant receives income-based jobseeker’s allowance, in which case there is a two-year time limit. The rules are also different if the claimant is receiving pension credit.

There were two key changes to SMI announced in the Budget. First, from 1 April 2016, the initial waiting period will be increased from 13 weeks to 39 weeks. In other words, borrowers will be expected to fund their mortgage themselves for around nine months. The relatively short 13-week waiting period was introduced in the wake of the 2008 financial crisis.

More seriously, however, from April 2018 the nature of the benefit payments will be changed radically. Instead of their constituting non-refundable benefits, they will become loans, on which interest will have to be paid as well as the upstanding capital. This means the whole amount of benefit will have to be repaid with interest when the claimant returns to work and earns enough. Alternatively, the claimant will have to repay the debt if they sell the home. The interest charged will be tied to the Office for Budget Responsibility forecast for gilts.

The justification for this change is that the Government needs to save money on the welfare bill and that people should not be subsidised for making an investment that has often been very profitable.

Of course, the people who will be most adversely affected will be relatively new buyers with high mortgages in relation to their incomes and often with relatively little equity in their homes. It remains to be seen how understanding lenders turn out to be when the full force of these changes start to be felt in two and a half years.

So what are the implications for financial planning?

The return to the 39-week qualifying period increases the amount of liquid capital clients should hold in an ideal world. There is a rule of thumb everyone should always have at least three months’ regular expenditure available to draw on. That rule has now been mightily reinforced.

Mind you, not many couples in their twenties or thirties (or forties come to that) manage to accumulate that sort of cash, especially if they have children. So the next best thing is to have access to such liquidity. Lucky ones have the increasingly popular bank of mum and dad to draw on; others need to line up availability of the cheapest lines of credit they can find.

Protection is the best answer: covering against death, illness and unemployment. Payment protection insurance got a deservedly grubby reputation but it makes good sense for anyone eligible who can find a good deal. And of course life cover, income protection and possibly also critical illness are essentials for any family.

Lots of advisers do not operate in the younger market any longer, preferring to advise the old and rich. They may not think these clients need to be concerned but they should think again: a call on the bank of mum and dad could turn out to be very expensive indeed if there were a death or serious illness in the family. Turn your older clients into life and health assurance salespeople. It will give their whole family peace of mind.

Danby Bloch is chairman of Helm Godfrey