Pension-backed mortgages a good idea, but...

The Retirement Benefits Authority (RBA) amended the Retirement Benefits Act in 2009 to allow members to use up to 60 per cent of their contributions as guarantee or collateral for home loans.

Under this arrangement, mortgage seekers can borrow 100 per cent mortgage (the full open market value of the property one is purchasing), thus removing the need for the borrower to raise the deposit, which has been a major hindrance to the growth of the country’s mortgage sector.

It also covers upfront closing fees such as stamp duty, valuation fees, legal fees, arrangement fees and mortgage protection fees. In total, one can borrow up to 115 per cent of the property value.

This is what the whole idea boils down to: Any borrower (of course one with accrued retirement benefits) who is unable to service his or her mortgage can fall back on their accrued retirement benefits to offset the outstanding balance.

A few days after Finance minister Njeru Githae read this year’s budget statement, RBA put newspaper adverts that highlighted “budgetary changes affecting the retirement benefits industry”. In the advert, there was nothing new concerning the use of one’s benefits to guarantee mortgage, but what struck me most was this statement:

“In the event of default by a member owing to loss of employment... the trustees shall settle the outstanding mortgage... as long as the outstanding loan is equal to or less than 60 per cent of the accrued benefit.”

This is generally a good idea, but one which is both poorly structured and timidly executed.

First, why restrict it only to loss of employment when we know there are many reasons that can make a borrower default on mortgage repayment? But that could be just a scope issue, which is not quite a big problem.

Early this year, I got information that the uptake of pension-backed mortgages was dismal. When I shared this with a seasoned mortgage player, the response was: “I didn’t expect it to go far. It can’t do fine because of the way it was structured.”

The idea of pension-backed mortgages is noble, the expert told me, but it needs to be structured in such a way that it enables the pensioners to use the money to pay part of the mortgage.

The main problem, the expert pointed out, was that as it is now, would-be pension-backed mortgage beneficiaries are actually using their pension funds to guarantee mortgage without actually getting the funding.

“The only thing it does is that it removes you from 85 per cent or 90 per cent to 100 per cent financing (because deposit is taken care of).

At the same time, it puts both your mortgage and pension at risk. Should you default, it is your pension that will pay for the mortgage. Personally, I don’t feel someone should put their pension at risk for a mortgage,” the expert said, adding:

“You don’t actually get the benefit of the funding. I wish it could give you the actual cash so that you can borrow cheaper.”

This is especially crucial, when you consider that those who use their pension to guarantee a mortgage do so after giving the property they are buying as the first charge.

In other words, while the “ordinary” borrower only uses the property they are buying as a charge, the pension-backed mortgage beneficiary risks both property and his or her lifelong savings. As a borrower, I would find this very scary.

Also, pension

The other problem that has been cited by industry players is the “long and tedious process” of having to write to the Retirement Benefits Authority to be allowed to use one’s pensions as collateral.

It is worth repeating that it is a good idea, but one which must be well thought out, structured properly and executed carefully.

My suggestion: Allow pensionable employees to use part of their savings as deposits on the house they are buying, not as collateral.

This will heavily reduce their monthly repayments, and even the number of years they take to fully own the property.

-backed mortgages hardly provide any meaningful incentive to borrowers. Covering both the deposit (which is usually a major entry barrier) and closing costs (on request, though) is well and good, but we already have some lenders in the market providing 100 per cent mortgage.

A serious borrower who gets a 100 per cent home loan would find it prudent to borrow closing costs from other sources like Saccos and bank personal loans rather than risk a life-time of pension savings.