One good feature of the National Pensions Act, 2008 (Act 766) is the fact that it allows benefits accrued to be used to secure a mortgage for the acquisition of a primary residence. This is not only to deepen the mortgage market but also to give workers the opportunity to own their first home at a very young age.
Unfortunately, over ten years down the line this aspect of Act 766 remains unutilized despite such a laudable innovation with respect to being the first in the country though this is not a new feature in other jurisdictions. This article intends to look at the features of a pension linked mortgage, how they are intended to operate, the reasons for the implementation challenges and product options that are likely to activate this aspect of the law.
PENSION LINKED MORTGAGES (PLM)
A Pension Linked Mortgage (PLM) is basically giving a loan to a person who intends to purchase a house where the source of repayment is from the benefits to be accrued from the purchaser’s pension. There are various ways in which this can be achieved depending on the financial profile of the purchaser with respect to age, present income, potential future income, accumulation period to retirement, potential investment returns, flexible or fixed interest rate and other economic indicators.
The “vanilla” PLM is where the mortgagor (financing company/bank) offers the mortgagee (purchaser/worker) an interest only loan to purchase a house and the principal will be paid off with the expected lump-sum to be received from the worker’s pension pay-out. What this means is the worker in the lifetime of the loan pays only the interest on the loan since the principal is secured with the lump-sum pension to be received in the future.
Some advantages for the worker are as follows:
- It increases the disposable income for other assets to be acquired unlike an ordinary home purchase loan when both principal and interest will have to be paid over the period.
- With time as income level increases the interest payment become negligible.
- Any interest rate increase will be offset overtime by a likely increase in income level.
- Allows the working youth to own houses at a very early age since the accumulation period can be longer over a period of 25 years.
- Should the lump-sum benefit at the time of maturity be more than the principal amount the worker gets the difference.
Major disadvantages for the worker are that:
- a drop in investment returns will affect the growth of the projected lump-sum and there might be the need to top up. This is however mitigated if the accumulation period that is the investment period of the worker’s contributions is longer.
- Unlike reducing balance, the principal sum remains unchanged hence the interest payment will remain the same if a fixed interest rate is taken. This is however not so much of an issue but any increase in income levels over the years which will make the payment almost negligible.
- Should a flexible interest rate be taken and rates increase, it would increase the interest payments but the worker is still better off with respect to disposable income as compared to, if both principal and interest were to be paid. In any case, the increase in interest rates will also positively impact on the investment returns on the lump-sum for a higher growth.
The table is an illustration of how a loan amount of a typical PLM should work. Kwaley who earns GHS7,407.41 can buy a property worth GHS800,000 if she started work at age 35 years to be paid off in 25 years’ time. If she however started work at an early age of 24 years then she would be contributing for at least 35 years and can buy a property worth GHS2m since her expected lump-sum is about GHS3.1m
Kwame who even earns just GHS500 can buy a property today worth GHS150,000 to be paid off with his lump-sum of GHS210, 795.98 in 35 years if he starts working at age 25 years. Adding tier 3 contributions, if any, makes it even better.
This shows we can all own houses no matter how much we earn but those with much lower incomes must buy their properties at an early age in their working lives, making the accumulation and investment period a critical factor in making PLM an opportunity for the youth. Of course, you must be employed and have job security which makes PLM a good product for government workers who to a large extent seem to have job security.
With job insecurity especially in the private sector, the lender might need to secure itself with some insurance product against unemployment eventually increasing the cost of owning a home or shy away from low-income earners in the private sector without critical skills. In any case, above 40 years you might have lost the opportunity.
|Basic Salary||Tier 2
Table 1: Illustration of Mortgage Loan Affordability using Tier 2. Interest rate of 13% and no salary increase assumed
MORTGAGE PROVISIONS IN ACT 766
There are two mortgage options under Act 766 that allows benefits to be used to secure a mortgage for the acquisition of a primary residence.
- Tier 2 linked Mortgage
Section 103(1) of Act 766, allows the worker to assign the lump-sum benefit under any occupational pension scheme to secure a mortgage for the acquisition of a primary residence with the operative word being “assign” not transfer. Any mortgage product should be based on the fact that the worker, the mortgagee, will still have the investment with the pension trustee but assigned to the bank, the mortgagor.
The product should be able to use the expected value of the future lump-sum benefit as basis for the loan and not the easy option of what the present accumulated value is. The accumulation period since Act 766 became operative in 2010 is just about 11 years.
A worker who was 24 years then would now be 35 years and has 25 years more to retirement which is a significant accumulation and investment period. To use today’s lump-sum value when the investment has 25 years to run would not allow workers to get suitable homes.
The no brainer option is to use today’s value to be equivalent to the 25% contribution required for the mortgage loan which the homeowner has to pay upfront. I have experienced situations whereby the bank wanted the investment to be transferred as deposit to them. It will be illegal for the trustee to transfer the money to the bank providing the mortgage loan.
- Tier 3 linked Mortgage
There is a bit of controversy in the interpretation of the sections related to using tier 3 benefits, provident fund and personal pension schemes, to secure mortgages for primary residence, so I am tempted to state exactly what the law as per Act 766 says so I can give the two schools of thought and give my preferred interpretation.
Section 113 (1) states that “A contributor may pledge or create a charge in respect of a part or all of the contributor’s accrued benefits”.
Section 113 (2) states that “A beneficiary who enforces a pledge or charge created by a contributor is liable for any tax applicable to withdrawals under a scheme”.
Section 114 (1) states that “A scheme shall have rules that prevent the assignment of benefit”.
Section 114 (2) states that “Despite subsection (1) a scheme may allow a member to use that member’s benefit to secure a mortgage for the acquisition of a primary residence but a member is not liable to pay tax on any withdrawal under this section.
he first school of thought which I will call the “Withdrawal School” is of the opinion that since section 113 allows pledge and withdrawal through enforcement of a pledge, the word “use” under section 114 (2) means “withdrawal” and the sentence “…but a member is not liable to pay tax on any withdrawal under this section” confirms the withdrawal. For the “withdrawal school” the value of the lump-sum at the time of getting the mortgage loan must be withdrawn and used as a cash deposit. This thought favours the lender and will not be surprised if they push for this.
The second school of thought which I will call the “Assignment School” is of the opinion that under section 113 the withdrawal is based on an enforcement of a pledge or a charge. Enforcement according to the Assignment School is subject to a default in the charge or pledge so there is no withdrawal at the beginning of the pledge or charge.
This school of thought are of the opinion that under section 114(2), the word “use” means “secure” and the sentence “…but a member is not liable to pay tax on any withdrawal under this section” is about when there is a foreclosure or the benefit lump-sum amount is sufficient to pay off the principal hence requires a withdrawal. This school of thought treat tier 3 linked and tier 2 linked mortgages the same.
My position is with the Assignment School for the following reasons:
- The withdrawal at the mortgage initiation stage does not make sense. How will the funds grow if withdrawn? If the lender wants the accrued benefit as the borrower’s (the worker) contribution, then where lies the linkage between the pension and loan. This means the borrower will have to be paying both principal and interest over the period of the loan with the pension lost. It is possible if the investment is allowed to continue but rather assigned, at an earlier point or on retirement have the lump-sum value to be more than the principal to be paid with the difference going to the worker. The withdrawal school in my opinion is a lazy, non-innovative approach based on traditional canons of lending of requiring a contribution toward the purchase price.
- Pension linked mortgages should allow 100% financing for home ownership with repayment of the principal secured by the value of the projected lump-sum, otherwise what is the point? Where is the young worker who has just started work going to get any contribution towards the purchase price of the house from. A good lender should even be able to finance ancillary costs such as legal fees and mortgage protection insurance under a different lending product.
- The Assignment School of thought allows for younger people to own their primary home once they start work to take advantage of the long accumulation and investment period without making upfront contribution towards the purchase price of the house.
- Assignment allows the worker to have both an asset by way of the investment fund and a liability by way of the mortgage loan. If property prices rise, the worker can decide to sell and pay off the loan and still have the investment running especially if a couple owned their individual homes before marrying and want to get rid of one.
A directive is required by the National Pensions Regulatory Authority to give clarity on this though I am biased towards assignment instead of outright withdrawal.
- Supply Side
Due to high inflation rate and unfavourable exchange rate to the dollar, mortgage loans have mostly been indexed to the dollar. There is lack of long-term funds to support the market with two mortgage companies, Home Finance Company and Ghana Home Loans, have had to convert into universal banks to build relatively stable retail deposits over time. It is quite obvious short-term deposits cannot be used to finance long-term housing projects. The financing company will run into liquidity crisis.
Prices of building materials have a direct correlation with the prices of houses. What is termed low-cost housing is really out of reach of the ordinary worker with those who can afford, buying and renting to the worker.
- Demand Side
Homeowners have had to struggle, earning cedis but making repayments in dollar and they seldom see any significant reduction in their outstanding balance due to depreciation of the cedi. One has to be earning dollars to avoid exchange rate risk when taking the dollar mortgages.
Youth unemployment and low incomes are other factors. Mortgages are long term investments and the demand side would require buyers who will be earning income over a longer period of time to be able to accumulate enough funds to pay off the loan. This has a direct impact of workers taking advantage of the home owner provisions in Act766. No work, no pension.
In any case pension linked mortgages is most likely the vehicle to increase home ownership. The providers of mortgage finance must however be innovative in their product offering to be able to take advantage of the mortgage provisions in Act 766 instead of the “vanilla” straight jacket dollar linked, 25% cash deposit mortgage finance. There is the need to think without a box to create very peculiar pension linked mortgage products relevant to our environment.
PENSION LINKED MORTGAGE PRODUCT INNOVATION
I have tried to think of a few high-level product innovations without the detailed risk management framework that may have to be put in place taking cognizance of our land ownership challenges, high interest rate, lack of long-term financing and employment opportunities. Personally, I am not too sure how feasible they are however, this may be a good start to provoke thinking. The underlying assumption is that the worker is not more than 35 years and can be eligible for a 25 years’ mortgage loan before retirement at age 60 years.
Some of the product names I have made up based on the concept and our peculiar circumstances are as follows:
- Land Owned Pension Linked Mortgages
This is a situation where the worker already has land acquired by way of purchase or a gift from a parent and needs a house but has no money to fund the building of her own house. She approaches the pension trustee to find out how much mortgage loan she can be entitled to base on her contributions and expected returns from the tier 2 and tier 3. The industry can even develop a standard pension linked mortgage calculator for the worker to do the calculation herself but a certification will finally be required from the pension trustee anyway.
The bank or financial institution links the worker to a partnered architect/developer to design, approve and build based on the amount certified or based on standard designs the financial institution has within the amount certified and the construction timeline.
The advantage for the worker is that the cost of the land is discounted from the cost of the building if the land was to have been owned by the developer. In addition, the worker would have the house on a land and an area she prefers.
The challenge with this product is that the land must be registered or without any litigation since no financial institution will want to be involved in such a land even though the land belongs to the worker and it is not in dispute. The new land Act 2020 (Act 1038) could reduce the risk but this is where some legal protection will have to be found since a lot of land will fall in this category.
- Part-Ownership/Low Start Pension Linked Mortgages
The worker might have just started work, may be single and wants to own a particular house that she can grow into even when married. The worker might also be expecting income level increases in future, a windfall in the future or has certain present commitments that will be extinguished in the future and needs to purchase a house now but cannot afford the full interest payment on the amount.
She therefore opts to co-own the property with another person be it another financial institution, the same lender, an individual investor or even a pension fund. She then pays rent to the financial institution or any investor who wishes to own part of the house whilst paying interest to the mortgage loan lender. This arrangement continues until such time when she can take another mortgage to buy off the other owner which should not go beyond the age of 35 years for the worker. The worker who for example takes this product at age 25 years will have 10 years to buy off the other co-owner.
One advantage to the worker is that the initial outlay is lower by way of payment at the beginning of the working life or during the time when the salary is not sufficient to accommodate the total interest payment on the whole value of the property not forgetting that certain ancillary cost such as mortgage protection insurance will be shared with the co-owner. The other advantage is that once the worker marries the spouse can take up another mortgage to pay off the co-owner or once she receives the expected windfall, she can pay off the co-owner which works out like a bridge finance for part of the value of the house.
Another advantage is that it allows temporary investment in properties by investors for rental income and the guarantee of being paid back their investment within an agreed period.
- Joint Pension Linked Mortgages
This is where a couple decide to purchase their first homes together with each assigning their lump-sum pension benefits.
The advantage is that they will together be able to get a much bigger property. The price of a four bed room house for example with its ancillary cost will be less than if each of them was to purchase a two-bedroom house. Also the four-bedroom property might be what each of them want but cannot afford on their own. It might even mitigate some of the stresses associated with the nexus of marriage and property ownership. Who knows?
- Principal Pay Down Pension Linked Mortgage
Situations may arise where the worker would periodically want to pay off part of the principal amount owed that originally was to be paid off by the pension lump sum or takes up a higher mortgage loan that the pension cannot initially support but is expecting a bulk payment in the near future that will bring it in line.
The advantage is that the worker whilst in active service can use bonuses, allowances or any windfall to pay off part of the principal which will not only reduce the monthly interest payment but will also release the encumbrance on the pension benefit. Also, can be used as bridge financing.
- Tailor Made Pension Linked Mortgage
This will allow a mix of any of the products to be matched with peculiar worker circumstances. Joint-principal pay down, part ownership-principal pay down etc.
SPECIAL PURPOSE VEHICLE OWNED BY TRUSTEES
The Trustees to come together to form a Special Purpose Vehicle (SPV), use their accumulated patient capital to partner landowners to acquire land, estate developers to build the houses themselves with standard designs. The SPV then sells to take advantage of their own Pensions Act. This is one sure way for prices of the houses to be as low as possible and be affordable to the ordinary worker.
Even if I have four plots of land, I should be able to approach this SPV and offer my land, for a developer to design, pre-sell, build and hand over. This same SPV will offer the mortgage loan at a profit. The SPV in this case makes income from the sale of the property as well as the loan being offered.
A young worker who already has land, either purchased by herself, devised through a will or gifted by the parents may also approach the SPV who would get a developer to design, build and handover with the SPV providing the mortgage loan. This arrangement would reduce the cost of the house since the value of the land will be discounted.
The advantage of this arrangement is the SPV wants to be paid back its investment and make sure of the quality of its security so will not only use quality materials but make sure the prices of the materials are not overpriced. The SPV can negotiate directly with suppliers such as cement and iron rod manufacturers directly to reduce the cost of the properties. This is a sure way of having the most touted “low-cost” housing since presently I do not see the low-cost aspect of the houses being built for sale.
This is what the business school scholars will call vertical integration strategy. Of course, there are associated risks that will need to be managed but will not be any much different from the inherent risk associated with an estate developer and a mortgage loan provider.
Do not ask which jurisdiction is doing it because no jurisdictions have the same demography, economic conditions and for that matter pension system. In the present economic environment, in taking advantage of the home ownership provision in Act 766, from the supply side especially, thinking outside the box is not even sufficient, we need to think without a box.
We should be thinking long-term for the youth and future generations and not us the present workers if we want to actualise the benefit of home ownership under Act 766. The goal of every young worker entering employment at age 24 years or earlier should be to own a house and immediately take up a pension linked mortgage so the accumulation and investment period can be meaningful. The cultural challenge is that our children will be leaving home early and the traditional Ghanaian parent must be prepared to let go. They might even be encouraged to marry early so they can take up joint mortgages with their spouses to share the burden and make their family’s disposable income even better. They can take holidays, reduce stress and live longer than us.
Additionally, the benefit for today’s parent will be that we will stop trying to either build big houses with so many rooms to accommodate all our children which ends up dividing them or end up as “white elephants” that cannot even be rented out upon our death. This pressure on parents is what at times breeds corruption. With time parents might feel the need to sell off existing big houses for smaller ones because the children have started working and acquired their own homes and moved out. The money can then be used to improve standard of living, better healthcare, take holidays and enjoy the fruit of their labour without thinking of the survival of the children. Life expectancy will gradually improve.
The landlord will have to reduce the rent since it will be better to pay towards buying your own home than paying rent. For a worker to rent, the rent payment must be below the interest payment towards a PLM and as income gets better the worker would choose to buy a house instead. The landlord will now be forced to adhere to the law of not taking more than six months’ rent advance with some even not asking for any advance.
Act 766 supports home ownership using one’s pension and is a brilliant innovation that requires some unorthodox financial engineering due to our present land tenure, financial and economic environment. This calls for strategic partnerships between the relevant service providers including land owners with the support of the National Pensions Regulatory Authority to start thinking without a box.
I take this opportunity to congratulate Enterprise Trustees and Ecobank for the partnership in wanting to take advantage of the provisions in Act 766 that facilitates home ownership. They should be practical and innovative in the product offering taking cognizance of our peculiar economic environment but workers must be able to seek independent financial advice on the choices available if possible.
Any financial institution wanting to enter this space must have patient capital for the long haul. Ordinary customer bank deposits do not have that endurance for the long-term and the conversion of the then Home Finance Company to HFC bank will attest to that. It is a secured profitable journey and not an instant profit-making event. I encourage the possibility of the use of the SPV by the trustees since there is no capital that is as patient as a pensions fund. It is not impossible and the dynamics, both legal and operational, can be worked out if there is the will.
The bottom line, however, of all this is that there should be an enabling economic environment for the youth to be employed since pension linked mortgages are employment linked as well and the surest way for the youth to own homes at an early age. The difficulty on the supply side is the mortgage loans being dollar-indexed and even if cedi denominated, the high interest rates will lead to foreclosures with workers eventually losing both their homes and pensions. We will end up blaming the Pensions Act when it would be more of an implementation issue in an unfavourable economic climate than the concept.
We must create the enabling environment for the next working generation to own homes at very young ages. Are we ready? I hope so.
The author is a Chartered Banker and holds an LLB. He was the former CEO of the National Pensions Regulatory Authority (NPRA). Contact: [email protected]