Mortgage Lender South by AliceBegovich


									                                                              SOUTH AFRICA

         Challenges in Mortgage Lending for the
              Under Served in South Africa
                                                 by Noah Kofi Karley, PhD

Introduction                                      very high interest rates of about 20 per cent     South Africa is about to sign off on a
                                                  a month or more. Unsecured loans are often        Financial Services Transformation Charter
Expanding access to finance can play a            provided by alternate lenders to low-income       that will commit the banks to substantial
very important role in reducing poverty           borrowers at risk-based rates of up to 43         lending to low income people for housing.
among underserved communities. Among              per cent per annum, which exceeds market          But risk associated to lending to the lower
other things access to finance can facilitate     interest rates often by several times. These      end of the market as the above example has
income-generating opportunities. The poor         experiences suggest that it is perhaps            illustrated requires partnership with
can also take advantage to build capital and      access to credit rather than an affordability     government so that risk is appropriately
improve their living conditions, especially if    problem, which is the main obstacle for           shared and mitigated. In this article we
they are homeowners. This is because              housing finance for significant groups in the     present further empirical findings on
homeowners are able to accumulate wealth          case of South Africa.                             impediments to institutional lending and
as the investment in their homes grows and                                                          household’s predicaments in borrowing in
they enjoy better living conditions.              However, there are other issues relating to       the context of a case study of Durban and
Unfortunately, financial exclusion is a           governance that inhibit lending to low            Umlazi in KwaZulu-Natal Province of South
common phenomenon in most developing              income people in South Africa. There has          Africa. We identify the major constraints
parts of the world, in particular sub-Sahara      been a politically motivated mortgage             and pointed out what needs to be done to
Africa. In most cases access to finance is        repayment boycott in the past, and currently      improve institutional mortgage lending and
inhibited by lack of well-developed financial     there are instances where banks are unable        borrowing by the under-served urban
system, inadequate infrastructure, limited        to repossess property in the event of default     market. As a prelude to the analysis, the
products, or affordability problems.              in certain areas and banks find it difficult to   paper provides an overview of the current
                                                  use courts to resolve the issues. For             situation in South Africa with regard to
Despite      South      Africa’s   relatively     example, evidence from the First National         demography, dwelling stock and needs and
sophisticated financial system compared to        Bank show that some areas in KZN                  nature of finance.
other countries in sub-Sahara Africa, it          province, townships had literally been
appears the housing finance system has not        divided into factions so that certain             The current situation in South Africa
been able to replicate for the low to             potential borrowers are unable to purchase
moderate income families a system that            houses in areas of their choice because           Demography
allows for their access to adequate formal        they are not affiliated to the faction popular
housing finance. Current challenges to            in the area. Also the bank stopped lending        With a rapidly increasing and urbanising
mortgage lending and borrowing in South           to low income borrowers in some                   society, South Africa’s population of 40.6
Africa cannot be overemphasised. The              communities because it was difficult              million in 1996 increased to 44.8 million by
issue of affordability is a major constraint,     repossessing on defaulted properties              2001 (SSA 2001), and projected to 49.8
but limited end-user finance has also greatly     belonging to certain eminent faction leaders      million by 2006. The number of households
restricted the level of effective housing         in the area. Further more, there are              in 1996 was estimated as 9.2 million, 11.2
demand especially in the low-income               instances where borrowers stopped paying          million in 2001 and projected to 13.1 million
housing market. While evidence shows that         their mortgages because of infrastructure         by 2006. However, given the rate of
many people are willing to pay the market         breakdown in the area. Thus, lenders are          HIV/AIDS infection and deaths related to the
interest rate most are unable to access           reluctant to lend for purchases in such areas     disease in South Africa, the above
funds. For instance, a study of the informal      because of potential loses associated with        population projections may not reflect the
credit market in South Africa indicates that      defaults, and also because intermittent           situation on the ground in the next 5 to 10
households seeking credit simply could not        service and infrastructure breakdown              years. According to Hacker (2002), about
get hold of finance except through the            diminish property values in the area.             19.9 per cent of adult population in South
informal moneylenders and pawnbrokers at                                                            Africa were HIV positive in 2000. The high

                                      HOUSING FINANCE INTERNATIONAL – September 2003                                                          27
                                                              SOUTH AFRICA

                    Chart 1: Estimates of Dwelling Stock and needs in South Africa (1996–2006)



                                                                                                                        Housing need
                                                                                                                        (million units)
         Number of                8
        dwelling units
          (millions)                                                                                                    Housing stock
                                                                                                                        (million units)



                                              1996                 2001                   2006

Source: Own calculations based on 1996 and 2001 data from Statistics South Africa website.

rate of HIV/AIDS related deaths implies the       housing stock at a time. Clearly, Chart 1       or more in South Africa is only about 20 per
rate of population growth could decrease by       shows a mismatch between housing stock          cent. Households unable to access
between 0.6 and 1.5 per cent by 2005, and         and housing need, which represents the          institutional loans consist of those deriving
3 per cent by 2010. There is substantial          housing backlog. The housing backlog of         incomes mainly from informal sector.
uncertainty about effect of HIV/AIDS on           about 3.3 million units in 1996 would           Approximately 45 per cent of these
population growth and demographic trend           increase to about 5.2 million units in 2006.    households earn gross income of less than
in general. The implications on housing           The consequence of housing backlog is           R2500 per month, about 25 per cent earn
demand and finance provision in South             physically reflected in overcrowding and        between R2,500 and R3,500 per month,
Africa cannot be overemphasised. But              prevalence of squatter and backyard             and about 20 per cent earn R3,500 or more.
these issues are beyond the scope of this         buildings especially around urban areas.        Currently about 70 per cent of households
paper and would not be discussed.                 The scale of the housing backlog and the        in urban South Africa are not able to access
                                                  rapid growth in housing need presents           institutional finance. New evidence from
                                                  many challenges to all aspects of the           Moss and Pillay (2000) suggests that among
Dwelling stock and need                           housing market - demand and supply.             households unable to access institutional
                                                                                                  finance, 41 per cent were not provided with
Taking the size of housing need as the                                                            mortgage loans mainly because of their low
equivalence of total number of households,        Housing finance                                 incomes and about 30 per cent were unable
South Africa’s housing need of                                                                    to access credit because they were
approximately 9.2 million units in 1996, is       Generally, lending institutions in South        informally or self-employed. Also, 29 per
projected to 13.1 million in 2006. The total      Africa consider gross income of less than       cent could not access credit partly because
housing stock consists of formal and              R3,500 per month (at 2001 rate of £1~R12)       of over-indebtedness. In most urban areas,
informal housing. From an estimated level of      as inadequate to support a basic mortgage       low and moderate-income households are
5.9 million units in 1996, it is estimated that   loan. However, there are numerous housing       self-employed, and their incomes vary
the housing stock would be 7.9 million units      loan initiatives as presented in Table 1, and   greatly and can be infrequent. This results in
by the year 2006. We define housing               products for income groups R1,500 to            a lack of interest by commercial financial
backlog in simply terms as the difference         R7,500 are currently being considered. But      institutions to lend to this market.
between the housing need (effectively, the        the proportion of working households
number of households) and the total               earning gross income of R3,500 per month

28                                     HOUSING FINANCE INTERNATIONAL – September 2003
                                                       SOUTH AFRICA

                           Table 1: Types of housing loans in South Africa and their attributes

Loan characteristics/         Main purpose of loan             Requirements and terms                Loan size and subsidy
Loan type                                                                                            eligibility

Conventional loan             – Provided by banks and          – Mainly offered to those earning     – More than R50,000 loan;
                                other major lenders for          above R3500 per month;              – Borrower not eligible for
                                purchase of formal houses      – First lien on house;                  government subsidy.
                                up to 80% LTV.                 – 20% down payment or
                                                                 employer guaranteed;
                                                               – Self amortisation over 20-30
                                                               – Mainly variable interest rate
                                                                 between 14 and 15%.
                                                               – Foreclose on default.

Affordable loan               – Provided by banks and          – Borrower must usually earn          – Up to R50,000 loan;
                                alternate lenders to bridge      R2500 or more, but lower            – Could get government up
                                gaps between what a              Income may qualify;                   front subsidy up to R23,100
                                household earns, deposit       – Pledge provident or pension;          (depending on income).
                                and monthly repayments.        – Employer guarantee;
                              – Up to 100% LTV.                – 20 years term;
                                                               – Variable and fixed interest rate;
                                                               – Up to 35% household
                                                                 payment-income ratio;
                                                               – Foreclose on default.

Non-mortgage loans            – Mainly offered by small        – Generally for low-income            – Up to R20,000 loan;
                                banks and micro lenders          earners in formal employment;       – Could get up to R23,100
                                for incremental house          – Pledge of provident fund,             government subsidy
                                building.                        payroll deducted;                     (depending on income).
                                                               – 2-5 years term at risk based
                                                                 pricing 13% above traditional;
                                                               – Provident fund taken on

Individual unsecured loans    – Usually offered by alternate   – For very low earners;               – Usually very small loan
for the informally employed     and micro lenders to           – Very short term (cash loan of 1-      (<R6,000);
                                informally employed to           3 months);                          – Could get up to R23,100 in
                                build their houses.            – Risk based pricing/up to 40 per       subsidy.
                                                                 cent over conventional loans;
                                                               – Defaulter denied further loan.

Unsecured micro               – Usually grant or soft loan     – Recipient must qualify              – Amount varies from donor to
loans and grants for            from benevolent                  according to donor means test         donor and according to
informally employed from        organisations to vulnerable      and policy and eligible for           recipient situation;
NGO’s                           or needy people to provide       government subsidy                  – May be eligible for
                                housing requirements           – Recipient enthusiasm to               government subsidy up to
                              – May be group based.              commit labour to programme;           R23,100.
                                                               – Small interest rate may apply;
                                                               – Defaulter denied further loan.

                                HOUSING FINANCE INTERNATIONAL – September 2003                                                       29
                                                             SOUTH AFRICA

The Durban-Umlazi study                          employed might behave differently when          for mortgage loan and the outcome. Each
                                                 attempting to access institutional finance      group is identified by attributes that
This is an exploratory study of mortgage         because unlike public employees, their jobs     determine level of affordability and/or
lenders in Durban and borrowers in Umlazi        may not be secure and they may have             accessibility applied by the various
Township, which is part of Durban                limited or no employer assistance.              institutional lenders, which include
Metropolis in the KwaZulu-Natal Province of                                                      income/employment requirement, savings
South Africa. It must be pointed out that the                                                    and deposit, collateral requirements, credit
findings presented relate more to sub urban      The Evidence                                    record, family size, other credit
housing and its financing. Housing finance                                                       commitments and level of subsidies and
in rural South Africa could well be different.   Data and analysis                               employer support. Based on these
The study involved a sample of 198                                                               conditions affordability ranges highest from
households made up of key workers in the         The basic criteria for lending that lenders     group 1 down to the lowest in group 5.
public sector, including teachers, civil         generally establish are that certain basic      However, it must be noted that, although we
servants and police personnel selected from      requirements are met. Thus, the potential       have classified respondents into five
Umlazi, an area occupied by blacks, and the      borrower must pass the five C’s (Character,     groups, there is no sharp demarcation
main five mortgage lenders in Durban:            Capacity, Capital, Collateral and Conditions)   between the groups; rather, there existed
ABSA Bank; First National Bank; Natal            assessment test. In simple terms this means     certain overlapping elements.
Building Society; Standard Bank of South         an attempt is made to establish that the
Africa; and Nedcor Group. The findings are       potential borrower is a person of good          From Chart 2 the proportion of successful
based on a sample of households. The             character who will pay back the loan; has       mortgage applications decreases as one
target household is the one that seemed to       capacity to pay; demonstrate capital and        moves to the right from group 1, an
have adequate income but found it difficult      wealth to have a financial stake in the         indication that lenders perceive higher
to enter the formal housing market because       property; show evidence of collateral           probability of default as income decreases
of the lack of access to private institutional   security; and be able to honour the             and/or when other requirements are not fully
finance. We focused on public sector             mortgage agreement in all conditions under      met. The proportion of Failed applications
employees because, a priori, they appear to      the terms.                                      also decreased as one moves from group 5
offer better security and less risk because of                                                   to the left, confirming lenders consistent
relative job security and government             Households in the study   are classified into   lending criteria. Detailed analysis of the data
assistance, yet many seemed not to be            five groups as shown       in Chart 2 and       suggests households with multiple earnings
getting access to institutional finance.         analysed according to      three categories     gained significant access to institutional
Private sector employees and the self-           based on whether or not   they have applied     finance. Although households in groups 1 to

                     Chart 2: Group classification by outcome of mortgage application (n=198)

                                                                                                                            Never applied
                          50%                                                                                               Successful
                                       1              2              3               4             5

30                                    HOUSING FINANCE INTERNATIONAL – September 2003
                                                              SOUTH AFRICA

3 met the income requirement, about 30 per        which were required by lenders as security          especially to low income borrowers and
cent in group 3 and 4 per cent in group 2         for mortgage loans.                                 that the transaction cost of lending for
were denied loans because their income                                                                low income is uneconomical.
derived from informal sources were not            From the survey, about 95 per cent
considered by lenders in determining              expressed        interest   in    becoming
access to finance.                                homeowners, yet nearly a fifth never applied     Borrowers’ perspective
                                                  for mortgage loans. Among those who
All successful applicants indicated that they     never-applied, over 70 per cent are between      • Households seeking credit simply can
obtained employer support in the form of          22 and 39 years, which is the age group that       not get hold of formal finance except
down payment (deposit guarantees).                institutional lenders are comfortable to offer     through the informal moneylenders and
Although many respondents were observed           loans. The data further show that the              pawnbrokers at very high interest rates;
to have household sizes greater than the          income (from all sources) of most of those
                                                                                                   • Household income is underestimated
average, the data show that some of such          who did not apply was sufficient to pay the
                                                                                                     because income from informal sources
respondents were successful in accessing          minimum monthly instalment required by
                                                                                                     (though often quite substantial) are
institutional finance. Thus, it suggests that a   lenders. Thus, most are potentially capable
                                                                                                     excluded from mortgage evaluation
large family size per se, does not inhibit        of accessing institutional finance. The
access to institutional finance, especially       problem, however, is that lenders do not
where incomes are relatively high. Many           consider incomes from informal sources as        • Household       ability    is   further
successful respondents felt they were             viable. Furthermore, due to the lack of            underestimated        because     while
granted mortgage loans by banks because           knowledge many had never applied for loan.         estimating household expenditure
of government interventions, such as the          They had learnt from people that banks             estimates lenders include total
provision of guarantees and the introduction      provide mortgage loans to only rich and            expenditure relating to all members of
of mortgage indemnity, which encouraged           mainly to white people.                            the family, the income does not take
lending to areas previously perceived as                                                             account of incomes contributed by all
posing risk to lenders. In particular, few        In a nutshell, while lenders aim to run low        members of the household;
respondents indicated that in the past they       cost and low risk business in order to
                                                                                                   • Inadequate borrower records and a rigid
could not access mortgage credit although         survive in the market, borrowers tend to
                                                                                                     evaluation process makes it appear as
their income was similar to their colleagues      believe that they are not provided the
                                                                                                     though low-income and unsophisticated
of other racial groups who had been               needed assistance to achieve their housing
                                                                                                     applicants are not creditworthy; and
granted institutional mortgage loans.             needs. From above analyses lenders and
                                                  borrowers perspectives can be summarised         • Many people are not aware of the
Detailed examination of the data show that        as follows:                                        implications and conditions of mortgage
many of those denied loans had larger                                                                loan or fully understood the concept of
families. This is probably because they                                                              homeownership through debt.
couldn’t provide enough evidence of               Lenders perspective
financial security to the lender in view of                                                        In order to ensure that institutions provide
their financial needs (large households) and      • Character: that many potential                 the needed funds affordable to borrowers it
capabilities (low incomes). However, most           borrowers are unaccustomed to formal           is imperative that these divergent
of them derived additional income from              credit and financial obligations. Thus,        requirements are reconciled.
informal sources, could provide additional          they have no credit record for proper
income security for institutional loans. But        assessment;
the banks do not consider informal income
                                                  • Capacity: that most have low and               Reconciling the divergent
in evaluating affordability. Some of those
                                                    informal incomes, and in relation to price     requirements: Policy suggestions
denied mortgage loans indicated that they
                                                    of dwelling it implies high default rate
were victims of circumstances. That is, in                                                         The issues emerging from the study shows
                                                    and insecurity for mortgage loan;
spite of their high incomes, their                                                                 perception of risks and costs associated
creditworthiness was affected because             • Capital: that there is general lack of         with lending especially to low income
banks did not have adequate records and             savings to fulfil the initial deposit          people can lead to financial exclusion.
information to evaluate their applications          requirement;                                   Given volatility in employment, affordability
properly. Some of the failed applicants also                                                       problems, and the complexity of the
                                                  • Collateral: that prevalence of slums and
indicated that they had wanted to use their                                                        conventional mortgage product, it would
                                                    backyard houses posed collateral risk;
land as collateral for the bank loans, but                                                         appear that the conventional mortgage
lenders were reluctant to accept it because       • Conditions:       that   macroeconomic         instrument is not appropriate for low income
most of the land is communally owned and            volatility creates cash flow and inflation     people and that some of the non-
did not have well-defined freehold titles,          risk and limits long-term lending              conventional housing loan initiatives

                                       HOUSING FINANCE INTERNATIONAL – September 2003                                                        31
                                                            SOUTH AFRICA

presented earlier in Table 1 could be more      We pointed out earlier that governance and        or market coverage, there would be a
appropriate for lower income people.            other non-commercial reasons which inhibit        corresponding increase in understanding of
However, if conventional mortgages are          housing finance needed attention. Although        the functioning of supply and demand
desirable, and given the divergent              for South Africa as a whole, less than 5% of      factors as well as of risk. As risk is better
requirements, perhaps programs that can         subsidised houses are credit linked,              understood, it can be either eliminated or
reduce lending risk can assure lenders that     evidence from the case study area shows           better managed. This has a direct
informal and low incomes are viable and         that government guarantees helped in              implication for cost reduction, improves the
can sustain mortgage repayment.                 attracting the private sector funding for         inflow of capital, increases the availability of
Government could deal with the conditions,      many house purchasers. Thus, given that           products and improves the prospects of
which affect access to finance but the role     many potential borrowers have inadequate          homebuyers and market participants
of lending institutions cannot be               incomes to fulfil the down payment (deposit)      through lower costs and greater availability.
overemphasised. Policy makers need to           requirement, it would be a worthwhile effort      Given the different levels of data and the
consider carefully deficiencies in the market   for government and/or employers to                capital required for development of such an
place, and the potential and limits of          develop guarantees for such households.           infrastructure, specialised institutions (both
market-driven needs of lending institutions.    But such programmes should separate               private and public) must be mandated to
                                                beneficiary groups facing different               collect such data. Perhaps government
Lenders in the study area exclude formal        challenges in accessing finance and               direct participation in such venture would be
incomes from the mortgage evaluation            develop different interventions for each.         necessary.
process in part because they believe that       This should be guided by principles of
incomes pooled through informal sources         efficiency. That is, it should aim at achieving   The absence of adequate and credible
are irregular and unreliable. Moreover, most    lowest cost per beneficiary and maximise          information and records to properly assess
informal businesses are not legal entities;     beneficiary contribution to avoid replacing       affordability and credit risk imply that
therefore lenders are reluctant to accept the   the expenditures recipient would make             lenders could be taking significant risk,
proceeds in legal mortgage contracts, as        anyway. Such initiatives could encourage          which is reflected in their styles of lending. It
they perceived the related credit risk to be    beneficiaries to contribute from own              is therefore may be necessary to introduce
high. Most individuals derived much of their    sources by for example, making own                an insurance or guarantee scheme
incomes from informal sources, but they are     savings a criterion to qualify for a subsidy.     (particularly from government) to help
reluctant to register their businesses                                                            mitigate the risk associated with lending to
because of tax requirements. Financial          The absence of adequate information and           households in the study area. Developing
institutions would be persuaded to believe      records on potential borrowers had been a         insurance/guarantee schemes, particularly
that informal incomes are viable if they can    major impediment for the mortgage                 for the self-employed, or informal earners
be assured that such incomes would              evaluation process and therefore the              and low-income borrowings, might be one
reliably provide adequate security for the      expansion of institutional finance. Investing     approach to reducing the risk perceived by
loan. One approach for government might         in a mortgage asset requires that borrowers       lenders. The basic argument here is that the
be to allow micro enterprises to operate        understand much the same information that         guarantee, especially by government, might
without tax obligations, at least for some      the lender must understand. The lender            be ‘cheap’ and could help households
time, which would encourage the                 requires understanding about the attributes       nowhere near the margin. Insurance is
recognition of such incomes as formal,          of the property that serves as collateral and     critical to mortgage development and the
making them more acceptable by lenders.         the market in which it resides, since the         needs of the real estate market in the study
This will make a significant improvement to     collateral will be received as security in the    area      are      considerable,       covering
affordability for many potential borrowers      event the borrower defaults. The lender also      unemployment and death as well as political
and also improve the working of the             needs sufficient information about the ability    and investment risk. The primary issues for
informal      business     credit    market.    and willingness of the borrower to repay the      development of insurance programmes
Contributions from extended family              loans in order to form expectations               include developing data for actuarial
members are not considered in determining       regarding risk and profitability of the           assessment and developing markets.
household affordability. But in an              investment. It is therefore important to          Significant health data could be gathered
environment where extended families are         develop an infrastructure for the collection,     from the government. Some western
common, such earnings constitute a              standardisation and dissemination of              insurers are already in South Africa, but their
significant part of household income. Thus,     household and property data, for the benefit      activities are limited to the upper part of the
acceptance of such earnings would               of participants in the mortgage market. The       market. This could be expanded to other
enhance affordability. This could be made       benefits of standardisation of data               segments of the housing market with
possible if legislation allows such family      collection and dissemination, or at least the     government providing credible support.
property to be available for foreclosure        promotion of it, are clear. As available data     Credible government guarantees can
when necessary.                                 increases in accuracy, quantity and activity      greatly reduce the risk of default. In general,

32                                    HOUSING FINANCE INTERNATIONAL – September 2003
                                                             SOUTH AFRICA

if the guarantee is not acceptable to the        counselling should almost certainly be an       References
lending institutions for any reason, the         essential part of mortgage finance process.
housing debt will not be and no private          A homebuyer programme might be                  Haacker, M. (2002) The Economic
institution would be willing to provide funds    established by institutions to help educate       Consequences of HIV/AIDS in Southern
required for house purchases.                    and counsel potential homebuyers who              Africa, IMF Working Paper No WP/02/38.
                                                 intend to borrower from lenders. The
                                                                                                 Moss, V. and M. Pillay (2000) ‘End User
The problem of accessibility, as revealed by     approach could be supported by
                                                                                                   Survey and Studies’, NHFC Research
the study suggests that inadequate               government, which appears to have great
                                                                                                   series, Johannesburg.
property rights militate against the desire to   confidence among the people so that they
expand institutional finance. Moreover,          may accept it. This programme could work        RDP (1994) ‘White Paper on Reconstruction
slums and backyard houses that pose risk         in different ways, particularly through one-      and Development Programme: A
to the property sales prospects are              to-one with a professional credit                 Strategy on Fundamental Transformation’,
prevalent in the study area. If a clear policy   representative who could help resolve credit      Pretoria: Government printer.
on land title were established, it would help    issues. Potential borrowers could be helped
to ensure that private property rights are       to establish saving plans and budget for        Statistics South Africa (SSA)(1996) The
recognised. This would generate a                deposits or connected with down payment            People of South Africa Population
significant improvement in accessibility of      assistance programmes. The programme               Census, Report No. 03-01-11(1996).
institutional finance because lenders would      could also aim to educate, guide and            Statistics South Africa (SSA) (2001): website:
be assured that the property had legal title.    prepare potential homebuyers for the     
Also landowners could borrow from banks          responsibilities of owning a home. The             SpecialProjects/Census 2001
by using their own land as collateral            benefits of such a scheme are the
securities for the loan.                         expansion of home ownership opportunities
                                                 and the provision of financing solutions for    Dr. Noah Kofi Karley is Research Associate
Finally, given relatively low levels of          those who couldn’t afford it. This could help   Heriot Watt University, Edinburgh, UK
knowledge with respect to housing finance        make the dream of home ownership a reality      Tel: +44 131 451 8182.
in the study area, borrower education and        for many more people.                 

                                      HOUSING FINANCE INTERNATIONAL – September 2003                                                        33

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