If you’re saving for retirement, your monthly contributions will slowly grow into a noteworthy asset. But did you know that you can use this as collateral when you take out a home loan?
This has been possible for some time. However, it may soon be possible to use your retirement savings as collateral for other types of loans as well. We investigate this and find out what your options are.
Tip: Find out whether you qualify for a home loan today by clicking here.
Separating good and bad debt
According to Kobus Liebenberg, marketing actuary at Metropolitan Life, you don’t want to mess with debt, but some things simply wouldn’t be affordable without it, such as houses or cars.
He explains that, having realised this, experts have classified debt as either “good” or “bad”.
“In simple terms, good debt can be described as money owed for things that can increase your monetary worth or income over time,” says Liebenberg.
“It includes home loans, student loans, or a business loan. The value of property generally increases over time and can provide you with a rental income. Student loans help you acquire new skills to apply for higher-paying jobs. Business loans help owners expand and generate additional profits,” he explains.
He believes that the long-term consequences of good debt can, therefore, be seen to outweigh the cost.
“Bad debt, on the other hand, includes credit cards or personal loans that are used to purchase non-essentials, such as extravagant cars or expensive furniture. These will not necessarily improve your financial wellbeing over time,” says Liebenberg.
With the distinction between good and bad debt in mind, retirement savings can currently be used as collateral for home loans, which is considered “good debt”.
Using retirement as security for home loans
Liebenberg says that the bank is more comfortable giving a loan when the borrower has an asset as security.
“This is in case you are not able to repay the loan in time, or if you pass away sooner than expected. If you can’t repay your loan, the bank will use the proceeds from the sale of the asset, or a life insurance policy, to repay the outstanding debt,” says Liebenberg.
He explains that according to the Pensions Fund Act, retirement savings can only be used as security for a home loan. However, it will depend on the rules of each specific fund.
“Remember, we are talking here about good debt. The loan will be limited to the maximum of your retirement savings at the time, or 75% of the value of the property,” says Liebenberg.
He says that, in general, this arrangement will only apply to occupational retirement funds, where there is an employee and employer relationship, and the employer deducts the loan repayments directly from your salary.
“Therefore, if you are unable to repay your pension-backed home loan, of which the cost will be the amount borrowed plus interest, your hard-earned retirement savings will be used instead,” he explains.
“To add insult to injury, you will pay retirement fund lump sum withdrawal tax on this as well. Withdrawal tax, as opposed to retirement tax, is generally more onerous and will also affect your tax-free amount which you are entitled to once you retire from the fund,” says Liebenberg.
With only 1 in 17 South Africans being able to retire comfortably, Liebenberg warns that your retirement savings shouldn’t be considered an easy answer to your heart’s wildest material desires.
“The government put additional measures in place on 1 March 2021 to make sure that South Africans do not unnecessarily access their retirement savings,” says Liebenberg.
“This should therefore prevent a younger you spending money on today’s needs at the expense of an older, more vulnerable, you,” he explains.
Retirement as collateral for other loans?
According to Walter van der Merwe, CEO of Fedgroup Life, it’s logical to consider retirement fund savings as collateral for more than just home loans. This is, in part, because “good debt” is not limited to home loans.
He explains that the main difference between a home loan and any other loan is that the former is an immovable asset.
“For example, if the loan is used to pay for a family holiday, it’s not suited as there is no asset. The family may need a holiday as a result of the lockdown and the stresses experienced as a result of the COVID-19 pandemic, but it’s still a luxury expense,” says Van der Merwe.
“In addition, many people have had a reduction in their earnings, and it will take some time for the economy to recover before their incomes will be restored. This has placed an additional strain on their ability to make loan repayments,” he explains.
What are the pros and cons?
Van der Merwe outlines the pros and cons of using your retirement as collateral when taking out a loan.
- 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 loan, saving you significant interest over time.
- Some banks waive certain fees including initiation fees, bond registration and property valuation fees. This makes it significantly cheaper than other home loans.
- 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 are unable to meet their repayments.
- Should you change jobs, the 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 can request your fund to settle the loan in full, from your withdrawal benefit, upon the termination of your membership. This will impact your future retirement funding.
- The level of guarantee would depend on the value of your retirement fund. For younger members, the value may be too small to offer a real guarantee. It does however create motivationnot to cash in retirement funds when changing jobs.
Overall, good or bad idea?
Liebenberg explains that there is a draft bill that proposes that the Pensions Fund Act should be amended so that retirement savings can be used for more than just home loans,for an “emergency similar to Covid-19”. But he stipulates that it has yet to be approved.
“Perhaps it’s a good thing that retirement savings remain as untouched as possible. The risk of smaller personal loans (or bad debt) potentially eating away at your retirement savings, could mean spending more paying off the debt rather than saving for retirement,” says Liebenberg.
“Don’t get me wrong, you can use your retirement savings to back your home loan if you have a stable income. By making use of a pension-backed home loan, you have the benefit of not paying bond registration fees and your retirement fund will negotiate more favourable interest rates on your behalf,” he explains.
To add to this, Van der Merwe believes it’s always best to live within your means and to save for the things that you want to own.
“There are circumstances under which you have no choice, especially with high-value items such as homes, for which you need to borrow money. This is acceptable as there is no other way,” says Van der Merwe.
“My view is that it’s best to be prudent and conservative. Having considered all the factors, I’m not in favour of extending the use of retirement funds for other loans,” he explains.
Before you can consider your retirement as collateral, you should start saving for your retirement.