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Pros and cons of a pension-backed home loan

May 3, 2021

If you’re looking at taking out a home loan, it may be worth enquiring whether you can use your pension fund as a guarantee for the loan.

Pros and cons of a pension-backed home loanA pension fund is permitted by the Pension Funds Act to lend a member an amount of money for the purposes of purchasing or renovating their home, so this is an option for a first-time home buyer to consider.

Although it is allowed by the Act, not all pension funds actually provide this benefit. It would need to form part of the pension fund rules, so if you are considering this option, you would need to confirm with your employer first whether your pension fund allows it.

According to the Financial Sector Conduct Authority (FSCA) 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.

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.

The property must be either owned by or be 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: some banks may limit the monthly installments to 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

The pros:

●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 waive certain fees including initiation fees, bond registration and property valuation fees. This makes it significantly cheaper than other loans.

●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.

The cons:

●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.

This article first appeared in City Press.

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Maya Fisher-French author of Money Questions Answered

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