If you are self employed, or not part of a company pension scheme then a personal pension plan can be a tax-efficient way of saving up the capital payment towards an interest only mortgage. Not everybody is eligible for a personal pension fund, which makes this a niche market. This method is widely regarded as one of the riskiest methods of paying for your home.

A pension plan mortgage will not be the right product for the majority of people, but for a small minority it can be a very good investment. Typically, a self-employed higher rate taxpayer who understands finance would find a pension plan mortgage useful.

You make monthly payments into a pension fund managed by a pension product provider. Your lender will want to know that the predicted growth levels for your fund are cautious to ensure that the loan will be paid off. The fund will mature on your retirement and you may withdraw 25% of the total pension fund as a lump sum which you would use to pay off the capital loan.

This means that you need to accumulate four times the capital repayment in your pension fund to be able to use it, making it unrealistic for a high value property.

Life insurance would not be included with this product, so would need to be taken out separately.

Advantages

A pension is a tax efficient way of saving, so can be a very good way of saving to pay off the capital on your home. This is because a higher rate taxpayer will receive tax relief at 40% on pension contributions.

If you arrange life cover with your mortgage, you can also get tax relief on these contributions.

A pension fund can generate higher returns than an endowment or an ISA because it is more tax efficient. Tax does not get charged on its investment income or on capital gains when funds are sold and replaced.

You could have a cash surplus on top of your capital repayment if you overpay into your plan or if it performs better than the assumed rate of growth.

Disadvantages

If you contribute to a company pension scheme you will not be eligible for a personal pension.

If your status changes and you start to contribute to a company scheme, you may be penalised for moving your investment.

Monthly contributions will be significantly higher than with any other mortgage as the amount that you can take out on retirement is capped at 25%. This means that the fund must be worth four times the value of your capital repayment.

There are limits on the amount that you can contribute to a pension, so if your capital loan is very high, it can be difficult to pay in enough money to reach the required amount.

You can not pay back your mortgage any earlier than your retirement date, so the plan should not be taken out more than twenty five years before this date.

Pension rules are very complicated making this an investment only for those who understand the market and the long term implications of this type of plan.

By using your lump sum to pay off your mortgage, you are reducing the amount in your pension for your retirement.