Simplicity enters the home loan market, but at what cost?

Simplicity have recently announced they will now offer home loans. There are several conditions:

  • It is for Simplicity Kiwisaver members of no less than one year only

  • It is for first home buyers only

  • It is for floating rate mortgages only

  • Initially the loans will be approved via ballot only. A total of $50 million of loans which will equates to less than 100 people.

  • A 20% deposit is required

  • You can only qualify if your mortgage repayments do not exceed 30% of after tax income.

  • Owner occupier loans only

  • No interest only loans

  • No guarantors

Just to name a few.

Simplicity will be funding the borrowing through their Kiwisaver and investment funds.

The CEO Sam Stubbs is quoted as saying “Instead of getting 1 per cent from the banks, with the remainder of the cost of a home loan going to fuel bank shareholder returns, Simplicity KiwiSaver will be getting 2.7 to 2.8 per cent. They will be winning, and the borrowers will be winning”

My issues with the Kiwisaver offering

1/. Portfolio risk

Based on what Mr Stubbs is saying is that Simplicity will fund their mortgage lending through client cash that is invested in low risk fixed interest investments such as banks, treasury bills, and bonds which are likely to be returning approximately 1.5% after costs.

The mortgages will be returning approximately 2.7% to Simplicity after costs. Could be even less. It costs a lot to manage mortgage investments.

1.2% extra returns. Woohoo.

Sounds great, but before you start celebrating have a think about the key to investing.

Getting the best return you can for the lowest risk as possible.

A 1.2% premium for a much higher risk product does not seem ideal for me.

For the level of risk involved in lending large sums of money to just a few people is extremely undiversified and I would expect much more than 2.7%.

And what if interest rates decrease further as predicted? Great for the 100 borrowers, but terrible for the thousands of investors. Will result in even lower returns!

I can think of many more investments that are similar risk than mortgage lending that will return more than that.

I expect my Kiwisaver provider to find somewhere better to invest my money than in medium risk residential mortgages for a measly 2.95% return.

Property index funds return well in excess of that over the long term.

You may say that because of the conditions imposed that these are not high-risk loans. But all it takes is a loss of a job or a reduction in income to go from financially secure to not being able to afford your mortgage repayments.

Simplicity is selling this as a replacement for fixed income investment. The difference in the level of risk is like night and day though. Mortgage lending is nowhere near the same risk as money in the bank.

It really is irresponsible of Simplicity not to warn investors of the added risk. Even worse given the fact that they are saying it will reduce the risk!

“It will have no impact on the Risk Indicator for each fund. The Risk Indicator is determined by the historical performance of the funds. We believe that over time, the new investment will reduce the risk of the fund as measured by the regulations, because its value will change less sharply than the longer-term bonds it is replacing”

Sam Stubbs

We have among the highest house price to income ratio in the world. We have one of the highest household debt levels in the world. Our debts are increasing each and every year and we are well and truly in record territory. Kicking the can down the road will only result in a bigger fall from grace.

What will happen when the economy tanks and people start bailing out of their obligations?

Inflated property prices and debts, and a declining economy are not a good combination.

The smallest of recessions will leave many under mortgage stress and default.

First home buyers, the target of this promotion, are more susceptible to default than seasoned mortgages too.

What happens if mortgage interest rates rise or incomes drop, taking the borrowers income to mortgage ratio to over 30%? Do the conservative investors know how much extra risk they are now taking on?

Are Simplicity explaining this to their customers? I have not seen this yet. For a company that constantly markets itself as looking out for kiwis, they need to tread very carefully here if they really do have the best interests of their investors at heart.

2/. Liquidity risk

Investments in banks and bonds can be accessed immediately. Now that they will be using that money for mortgage lending, then that ability to turn their investments into immediate cash is gone.

As long as they continue to attract new members and don’t have a large influx of withdrawals it should not be an issue, but one to keep an eye out for nonetheless.

3/. The rich getting richer

Let’s not fool anyone. You need to be a high earner to qualify for these loans.

The median household income in New Zealand is approximately $105,000. We will assume a couple earning $52,500 each for a combined after-tax income of $86,000.

To qualify for a loan their mortgage repayments can’t exceed 30% of $86,000. Which means a 30 year mortgage of $2,150 per month.

This means a mortgage of no greater than $513,000.

For a single person it is a mortgage of no greater than $473,000 due to higher tax obligations.

For them that would rule out any house less than $591K to $641K, which rules out the majority of Auckland.

Yet in Simplicity’s promotional material they are using a $600K home loan as their standard for lending. That is a $750K house with a 20% deposit.

As per their own promotional material, their target for a $750K house then would have to be earning $100,600 after tax. Which is a pre tax income of $136,600 for a single person or $126,300 for a couple earning $63,150 each. Their target must earn significantly higher than the median household incomes.

This is 20% to 30% higher than the median household income that they are targeting.

The average first home buyer also earns less than the median income and are less likely to be in a financially combined couple than a second or third home buyer.

Simplicity is supposedly about helping every single kiwi according to their manifesto. Yet this initiative is only helping the most well off.

4/. Marketing gimmick

For many of the reasons mentioned already is why I see this as just a clever marketing gimmick.

Mr Stubbs has made his dislike for the banks very public. A lot of kiwis don’t like banks, so he has managed to tap in to an idea that will generate a lot of support from the anti-bank brigade.

Banks are an easy target and Simplicity know that.

Simplicity have stated that the interest rate will be approximately 20% lower than the 1-year average of the big banks.

This offering is to satisfy Mr Stubbs and Simplicity, not the investors.

This will have no impact on the banks either. Simplicity are loving the fact that people are now talking about this disrupting the banks. It won’t.

Simplicity have set aside $50m for the first 6 months. This is only 0.02% of total mortgage lending in New Zealand.

It’s really just a lucky draw for a small amount of people in order to attract new business. Nothing more than a dig at the banks in an attempt to increase members.

5/. Lack of product flexibility

Mortgages have come a long way. There are now many different types of products to suit your needs. You can fix for varying lengths of time. You can get interest only loans and offset loans. You can use your home as leverage to purchase your next property. You can decide to rent out your home. You can redraw some money from the mortgage. You are allowed guarantors.

None of these things are possible under Simplicity’s conditions.

Mortgages are not just about the lowest rates. Other mortgage offerings are often important to people too.

Some like to have their loan, or a portion of their loan, in a fixed mortgage. They like the certainty of repayments.

Others like to be able to redraw some money in case of an emergency or some other funding requirement.

Certain people like the option to pay interest only during certain periods of time. Maybe they have had a drop in income, and this will allow them to survive until they are better off.

What happens if I decide I want to use this first home as leverage to buy a second property? Or if I want to turn this property in to a rental? Simplicity’s conditions do not allow this. I would be forced to either remain in the house or sell it. Or leave Simplicity.

These extra options and flexibility are worth the extra 0.5 to 1 percentage points in interest rates for some people.

6/. Encourages more Kiwisaver withdrawals

I’ve discussed my concerns with an increasing number of people tapping in to their Kiwisaver funds in this article here and also here, so I won’t go in to too much detail.

But by having your Kiwisaver and mortgage in one place it encourages further use of Kiwisaver funds through greater ease of access.

Due to unaffordable house prices, we are buying houses later than ever. Therefore, we are paying off the mortgages later than ever. More people are carrying larger mortgages in to retirement than ever before and this will only get worse. This is when you wish you had more in your Kiwisaver account.

7/. Specialty of advice is diminished

The more Simplicity tinker with other products, the more unspecialised they become.

Even though they are offering mortgages, they are not a full-service mortgage provider. As discussed above their products are very limited. Variable 30-year owner occupier loans only.

If they aren’t careful they will also take away from their core investment business.

A less than 3% return for a medium risk investment is not a good return for their investors.

They don’t want to be caught in the middle ground where they become average at both, instead of fantastic at one.

8/. False promises

In this Stuff article, which Mr Stubbs is a regular writer at through his paid marketing efforts (no conflict of interest there right), he states that a first home buyer will save $6,000 a year on a $600,000 mortgage.

Let’s take a look at that.

A $600K 30-year mortgage at 2.95% through Simplicity would cost $30,156 a year.

A $600K mortgage through any bank at 4% would cost $34,368 a year.

That is only a $4,000 difference and I have used a high interest rate of 4%.

Who in their right mind has a 100% floating mortgage at the current rates? For Simplicity to use that as a benchmark is disingenuous at best.

This also doesn’t include all the fees that banks usually cover when you ask them. Legal fees, loan application fees etc. Banks often also provide large cashbacks to have your business too.

All these factors will close that gap.

Simplicity don’t offer those reductions in fees.

In fact, they are charging establishment fees and compulsory house valuations that will come out of your pocket. And definitely no cashback incentives.

Over the long term, the Simplicity rate should leave the lucky few better off, but it is not by as much as Mr Stubbs has stated. New Zealander’s historically have preferred fixed mortgages over floating.

From someone who holds himself up as morally superior and calls out other providers for not being honest, use of these half-truths to create unrealistic statements is disappointing and somewhat hypocritical.

If you hold yourself up to higher standards than others and talk the talk, you need to be able to walk the walk.

Final Thoughts

I realise I’m touching a hornets’ nest with this one. Simplicity is the do good favourite son or daughter of many people. And for good reason. They have done great things for investors in New Zealand.

I recommend Simplicity funds to many of my clients due to their low cost and diversified funds.

However, I am not a fan of this latest offering. In case you haven’t guessed already.

It is great if you are one of the less than 100 people who get a loan through the ballot process and don’t mind a simple loan with limited flexibility.

For their thousands of investors though, I see this as a distraction from their main business of investing and the addition of a medium risk investment product for such low returns is not in the best interests of investors.

Investors who don’t know what they are invested in and trust Simplicity when they say they are in a low risk fund, may be in for a rude awakening.

This is not a low risk offering and for this level of risk investors deserve much more than 3%. For arguably less risk you can invest in a REIT property fund for greater returns. The returns are more volatile but it is far more diversified.

If Simplicity decide to continue the offering past 6 months, then it will only exacerbate my concerns.

  • Low risk funds will become even riskier

  • Funds will become more illiquid

  • The gaps between the haves and have nots will grow which goes against everything Simplicity stand for

  • More people will be tapping in to their Kiwisaver accounts far too easily

With a likely OCR cut in the near future, interest rates will be decreasing again. This will lower investor returns even further.

Not only that but short-term house prices will likely increase due to more people wanting to buy houses at lower interest rates. This will just push the criteria for meeting Simplicity’s conditions even more difficult.

All the best to Simplicity, but I can already see damage to their current investors. Simplicity are letting personal vendettas against banks get in the way of quality of investment. The most basic of which is being ignored - the risk/reward trade off.

This offering has not been made to benefit its investors. It has been made to satisfy Simplicity’s moral standing and less than a 100 high income first home buyers.

I hope this marketing gimmick doesn’t hurt them too much and that the extra customers they gain make it worth it for them.

The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here.