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Turning a home into a pension

South African financial institutions could learn a thing or two from innovations abroad that provide for retirement.

Many people consider their homes, which they intend to sell on retirement, as their pension. The problem is that downsizing does not necessarily save money as townhouses, clusters or retirement villages often carry a premium price, and the costs of selling and buying can be as high as 20% once intermediaries have been paid.

In the United Kingdom, United States and France, a home can literally be turned into a pension annuity. In the UK, this is called an equity release scheme. The principle is that you benefit from the value of your home without having to move out of it. Such an option could revolutionise pension funding in South Africa.

Most people have paid off the bulk of their mortgage bond at retirement, allowing them to re-mortgage and either receive a lump sum or receive an annuity from the bank.

If a lump sum is opted for, repayments can be rolled up and, upon death, the bank sells the home and recoups the outstanding debt. In the UK, “home reversion companies” take an equity stake in the property.

For example, a retired 70-year-old person may sell half his home to a reversion company. The company pays less than market value to compensate for the fact that it has to wait until the person dies or no longer needs the home before it can recoup its capital.

When the customer dies or moves out, the property is sold and the company receives half the value of the home, which could have gone up substantially in value. The remaining half goes to the estate.

FinMark Trust’s Kecia Rust says a common equity release scheme in the UK is based on a reverse-equity mortgage. The bank buys the house and provides a monthly income. For example, the client takes out a mortgage of R1million, after 10 years the client has paid off R700 000 and now wants to retire. The bank effectively buys the house from the client and pays the client a monthly mortgage repayment based on the R700 000.

The problem is that once the bank has repaid the R700 000, the retiree will no longer receive any income, so the client needs to understand the risk and use it to augment retirement funding leaving other investments to grow and take over as a new income stream at a later stage.

In principle, people do this every day in South Africa by borrowing against the value of their home for renovations or consumption. However, South African banks shy away from using the mechanism to provide for retirement as they prefer to receive monthly repayments than wait to profit from the sale of the house many years later.

Richard Pembroke of mortgage brokerage Bond Busters says South African banks do not take a long-term approach to home ownership, as is the case in the UK.

The inflexibility of local banks was highlighted by a call Pembroke received recently. The client, a 93yearold, owns a home worth R1,5million, which is mortgaged. He has no dependants. Before he dies he would like to throw a really big party for his friends.

He wanted a R250 000 loan against his house, to be repaid on his death with interest. Pembroke says the bank managers nearly fell off their chairs at the request. There was absolutely no way they would lend money to a 93-year-old.

Pembroke says that in the UK this would have been a viable option. By not being flexible, banks and clients are losing out on a mutually beneficial opportunity.

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Maya Fisher French
Guest Author

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