A pension fund is usually the largest asset owned by an individual and it makes sense that it could be used to provide collateral for a home loan, especially for a first-time home owner. This benefit also encourages individuals not to cash in their retirement funds when changing jobs.
In terms of the Pension Funds Act, a pension fund is allowed to lend a member an amount of money for the purposes of purchasing or renovating their home. Although it is allowed, not all pension funds provide this benefit which would need to form part of the pension fund rules, so you would need to confirm with your employer first.
Gerry Anderson, chief operations officer at the Financial Services Board says the pension fund can either lend the money directly or, as commonly is the case, can issue a guarantee to the credit provider. Usually the pension fund would work with a specific bank to offer the benefit to their members.
The amount of money that can be lent to the member is limited by the Pension Funds Act to 90% of their retirement funds, however individual funds have their own limits. For example, the FSB’s own pension fund rules limit the amount their employees can borrow to 60% of their pension fund assets.
Banks usually offer a specialist product to cater for pension-backed home loans, and the monthly instalments are deducted from the employee’s salary each month by the employer. The employer would also consider the affordability of the loan before approving it.
The loan can be used to buy an existing home or to build a new home, settle an existing home loan or improve an existing home. In many cases, especially for a first-time homeowner, the value of their existing retirement fund may be too small to underpin the home loan but could guarantee a loan to be used for the deposit for purchasing a property or to pay the transfer and bond registration fees.
According to Absa, which offers a product entitled Pension Powered Home Loans, the property must be either owned by or in the process of being transferred to the employee or their spouse and must be used as the primary residence of the employee – so it could not, for example, be used for an investment property.
There are also limits in terms of your monthly repayments; in the case of Standard Bank’s pension-backed lending scheme, the monthly installments must be no more than 25% of your monthly income.
The installment is usually fixed in order to assist the employer in managing their payroll deductions. That means in the case of interest rate increases, the length of the loan would be extended.
The maximum period of a loan is usually 30 years or the length of time to your normal retirement age, whichever is lower. In other words if you are 40 years old and your retirement age is 65, you could only qualify for a 25-year loan.
Pros and cons
- If you don’t have a credit record, the loan guarantee improves your risk rating and the bank will be more likely to issue you with a home loan.
- As the risk of the loan is reduced, banks will offer lower interest rates on the home loan, saving you significant interest over time. Pension funds will often work with a specific bank that is prepared to offer their members a lower rate.
- Some banks, as in the case of Absa and Standard Bank, waive certain fees including initiation fees, bond registration and property valuation fees. This makes it significantly cheaper than other loans.
- If you default you will put your pension fund at risk. If a member defaults, the fund is then required to settle the outstanding amount of the pension-backed loan.
- From a fund perspective, there is a risk that individuals are encouraged to take on excessive debt in the knowledge that their pension fund could bail them out if they were unable to meet their mortgage repayments.
- Should you change jobs, the home loan would have to be repaid. You could arrange with your new employer to continue with the payroll deduction of the loan and to arrange with your new fund to stand surety for the loan. Alternatively you would request your fund to settle the loan in full, from your withdrawal benefit, upon your termination of your membership. This will impact your future retirement funding.
- The level of guarantee would depend on the value of your retirement fund. For younger members their value may be too small to offer a real guarantee. It does however create a motivation not to cash in retirement funds when changing jobs.