A pension-backed home loan is an alternative form of housing finance where a person uses their pension savings as security for a home loan.

When you apply for a home loan, the bank will consider the property as security for the loan but will also look at your risk rating. In some cases, the bank will require someone to sign surety, especially in the case of a 100% mortgage. This is where pension-backed lending can become an important financial tool.

Heetal Govindjee, Head of Personal Lending at Standard Bank says that this kind of home loan is regulated by strict laws, but it is an option for many individuals who have saved up substantial retirement funds.

It is important to note that this is not the same as drawing down on your pension fund. You still have to repay the full loan, and your pension funds remain intact. It is only if you default on the loan that the bank would have a claim against your pension fund.

Key factors when considering a pension-backed home loan

Govindjee warns that taking up a pension-backed loan is a significant financial decision, so it is important to carefully evaluate various factors before considering this type of home finance.

Here are some key factors to take into consideration:

Collateralisation

In a pension-backed loan, the pension fund serves as collateral for the mortgage. An agreement must be in place between the bank, the pension fund and your employer before you can apply.  Not all pension funds provide for this, so you need to check with your employer.

Loan amount and eligibility

The loan amount you qualify for depends on the size of your retirement fund. The allowed maximum benefit as per the fund rules and your ability to repay your loan is guided by the National Credit Act.

Lenders may also consider the borrower’s employment stability and the likelihood of continued contributions to the pension fund when approving such loans.

There are also limits in terms of your monthly repayments: some banks may limit the monthly installments to no more than 25% of your monthly income.

Interest rates

Normally when applying for a home loan, rates are based on a client’s credit risk profile. In the case of a pension-backed loan, favourable interest rates and fees are negotiated at the pension fund level, meaning that all members of that fund will enjoy the same rate.

For some people, that could mean a better interest rate and lower fees. However, the installment is usually fixed 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.

Repayment structure

Repayment terms may vary, but typically, repayments are structured to align with the borrower’s employment and retirement timeline.

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 termination of your membership. This will impact your future retirement funding.

This article first appeared in City Press.