Pension Supported Housing Loans - A shield for consumers from further rate hikes

With total interest rate increases amounting to 4% since June 2006, consumer purchasing power in the home finance sector has effectively been eroded by a significant 20%.

The continued rise in both consumer and producer price inflation to levels well beyond the inflation targets set by the South African Reserve Bank means that interest rates at best will remain at their current, relatively high levels.

There’s a chance that they may even have to rise by 50 or 100 basis points at the next few Monetary Policy Committee meetings.

Most economists now believe that the current relatively high interest rates will be maintained for at least the remainder of this year and possibly into the first quarter of 2009. This will have a dampening effect on consumer spending, as the cost of using credit to buy goods will remain expensive and may become even more costly.

Gavin Opperman, Managing Executive of Absa Home Loans says: “Although we are a long way from the 25.5% prime rate achieved in the late 1990s, the current interest rate level has come from a particularly low base, making it feel more painful than it otherwise might be.”

This is exceptionally bad news for most people and especially bad news for lower income consumers, who have been hardest hit by the impact of higher food prices and fuel costs and who also have to contend with sharply higher interest rates.

These consumers tend to have very little discretionary spending power and are easily disrupted by rate hikes. They are now even more hard-pressed to enter into the housing market or to act on aspirations to improve and upgrade existing homes.

In an increasing rate environment, as we have seen in South Africa over the past few years, Pension Supported Housing Loans (PSHL) offer some unique advantages to consumers needing housing finance. Unlike conventional loans such as personal or microloans, the rate of interest on a PSHL doesn’t automatically rise when the prime lending rate does.

PSHLs offer two payment options, the one being a variable monthly instalment based on the applicable interest rate and the other a fixed monthly instalment. In the case of the latter option, the monthly repayable figure remains fixed – it is rather the term of the loan, usually originally set at ten years, which can be extended. The term of the loan is set by the pension fund trustees.

This means that this class of borrowers doesn’t feel the pinch to the same extent as if they had traditional credit finance. Although retirement fund trustees have a say in determining whether or not a PSHL can be extended, the general principle of extending the loan occurs automatically.

This means that when this option is chosen PSHL borrowers need do nothing if and when interest rates rise—the term of the loan will be automatically extended, monthly payroll deductions will remain the same and the borrower does not have to compromise in other areas of his life.

This principle is one of the core philosophies behind the NCA which aims to prevent consumers from falling into debt-traps and a nasty spiral of having to service increasing monthly debt.

PSHL borrowers not only have the advantage of being able to extend the term of their loans but they also tend to get preferential interest rates compared with what they would normally be offered by a banking institution or micro lender.

With PSHLs the interest rate could be as low as prime less 2% as the rate is determined according to the retirement fund profile, rather than on a risk assessment of the borrower. There are other smaller cost advantages such as no bond registration or initiation fees.

PSHL are overseen by retirement fund trustees who have a fiduciary responsibility towards members and their best interests at heart. This contrasts with the objectives of other lenders who wish to maximize their returns as a priority.

Pension Supported Housing Loan (PSHLs) are loans offered to members of a pension or provident fund for the purpose of buying or building a house or making improvements to an existing home. The advance has to be used for a “permanent structure”, so shacks and other forms of temporary accommodation do not qualify.

The loan is offered against the security of a certain percentage of the member’s available post-tax withdrawal benefit in the retirement fund. The percentage is determined by the rules of the fund and by how much each member can afford to repay every month.

A percentage of the member’s share in the retirement fund is used as collateral security for the PSHL. The tangible asset, being the house, is not used as security so will not be lost in the case of loan default. The retirement fund guarantees the loan but if the member leaves the fund before the loan is repaid the outstanding balance must be settled.

On application for a PSHL, the lending bank will examine the member’s monthly income and expenditure in terms of the requirements of the National Credit Act to ensure that they are not over-indebted. As with all loans, applicants are provided with information to assist them in understanding the implications of the loan and avoiding financial over-commitment.

The lower end of the housing market, where PSHL loans are most prevalent, is still relatively buoyant and there are signs that building costs are now starting to rise at a slower pace. Refurbishment and renovation is increasingly being preferred to upgrading through the route of buying a new house and various improvement finance options are opening up for those who previously would not have been approved for credit.

As the funds from a PSHL can only be used for housing, various checks and balances have been designed to ensure there is no leakage into other types of spending and pre-loaded cash or debit cards aligned with suppliers of building materials are used. In addition, Absa has appointed assessment companies to verify that the expenditure was as meant to be.

With the slow down in property sales in the middle to upper end of the market and the effect of the Eskom crisis on new property developments, it may often make more sense to do renovations and extensions to an existing property, than to buy another property.

Furthermore, PSHLs don’t incur additional fees such as bond registration fees, monthly administration or bank charges (in the case of some banks), making them an even more viable option.

PSHLs clearly play a crucial role in addressing the dire housing shortage in SA. The Financial Services Charter has made a significant contribution in reducing the housing backlog, well exceeding its R42 billion housing origination target, with R16,6 billion coming from non-mortgage financing such as the PSHL.

By Pieter Vorster (pictured above right), General Manager: Pension Supported Housing Loans from Absa