A lack of retirement savings has seen a significant demand from pensioners to use their homes to access capital, especially for medical costs.
A reverse equity mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash, but unlike a regular mortgage, you do not have to make monthly repayments. The loan is capitalised and repaid when you sell your property. As this is only available to individuals over the age of 65, this is usually when the borrower moves into a retirement village or on death.
The concept of a reverse equity mortgage has been around for a long time and is popular in countries like the UK, Canada and the US, but it has never been mainstream in South Africa. In countries with strong property markets and relatively low interest rates, a reverse equity mortgage can make sense for retirees, but in South Africa the landscape is more challenging.
Around the mid-2000s Nedbank introduced the Nedbank Home Income Plan, but the bank found that it was not economically viable especially after the credit crisis of 2008 and closed the business, although it continued to service existing clients.
More2Life is a new player that has entered the South African market. Director Anton de Waal says the demand for loans is outstripping their ability to fund them, with retirees mostly applying for loans to fund medical expenses or because they are not quite ready to sell and move in with the kids. This is despite the fact that these are relatively expensive loans and have received negative press both locally and globally. The industry attracts fly-by-night operators who prey on desperate pensioners, but there is also the issue of property values.
Eating into your home equity
Unless you are extremely conservative in the amount you borrow against the property, the compounding interest could soon use up all the equity in the home. In South Africa, interest rates on the loans are around 14.5% which means within five years your outstanding loan would have nearly doubled in value. Given the current property environment, it is very unlikely that your property value would have increased by 14.5% per annum which means a portion of your home equity will be given to the lender in the form of fees and interest, rather than to your own retirement funds or your estate.
In creating the product for the South African market, de Waal says they had to adapt for the National Credit Act which does not make provision for reverse equity mortgages. Therefore, these loans are only issued on a five-year basis, and are then renewed if the individual does not wish to sell at that point.
Although de Waal says they only issue loans to properties in areas with a good track record in property growth, if property prices have been depressed then it may not be possible to renew the loan if the loan and interest have now exceeded 65% of the value of the property.
“Our market research shows that most clients plan to use the product for 5 to 10 years before settling in what they deem to be their final accommodation/retirement village etc. If we have feedback from a client that they intend to live out the rest of their lives in the house then we tailor the loan so as to make sure that this is possible. In some cases, after a lifestyle audit, if we feel that the loan will not allow for this we reject the loan based on the fact that they will find themselves in a position of a forced sale.” De Waal adds that the maximum value of a loan, including compounding interest, would be 60- 65% of the value of the property.
De Waal says More2Life are in the process of creating a securitised special-purpose vehicle (as used by home loan company SA Homeloans) which will give them access to more competitive financing which should lower the interest rates.
Given the demand for reverse equity mortgages, it is likely that this sector will grow further and there are already two potential new market entrants.
How it works
A reverse equity mortgage can be an expensive and legally fraught way to borrow, so you need to understand the risks and costs before proceeding.
- Although the interest rate of 14.5% is lower than an unsecured loan, the fact that it compounds makes it expensive. There are also upfront fees in the range of 15% of the loan which cover a physical inspection of the house, admin fees, bond registration fees etc.
- The amount of the loan will be determined by your age and the value of your property. As the total loan value should never exceed 65% of the value of your home, the starting loan will only be around 10% – 20% of the value of the property, depending on your age.
- Your property must be worth R1 million or more to qualify as the costs (starting at around R20 000) are too high for lower values. The property market in your area will also be a factor in the decision to issue the loan.
- The property has to remain your permanent residence. If you move out or die, the loan will become due. This could impact your spouse or any family member living in the property, although arrangements can be made for your spouse to take over the loan, as long as they are over the age of 65.
- If you are married in community of property both spouses will have to sign the loan agreement and the loan will be based on the age of the younger spouse.
- If you do not maintain the property or do not keep up with your property taxes, the company has a right to terminate the loan. If you cannot afford to settle the loan you have up to six months to sell the property.
- Owing to the mandatory costs associated with a reverse equity mortgage, if you intend to leave your home within two to three years, there may be other cheaper options available. If you want to leave your home to your children, then you should consider other options, because in many cases, the home is sold to pay back a reverse equity mortgage.
An individual aged 70 with a R1 million home would receive a loan of R120 000. Costs of around R20 000 would be deducted so the net loan would be R100 000.
Depending on the interest rate, after five years the individual would owe approximately R240 000 which is double the value of the original loan. This would be about 18% of the value of the property, assuming 5% annual growth. At this stage the individual could either opt to sell and settle the loan or extend the loan.
This article first appeared in City Press.