17 September 2014

Mortgage tips for would-be home owner

So you have found your dream home. What next?  Can you afford to buy a home just by paying cash?  Even, if you did have that much cash, you might still want to finance your dream home to cover part of the purchase price. Choosing the right mortgage is as important as choosing the right home!  Here are some tips for would-be home owner.

Tip 1: Work out your monthly cash flow and then go mortgage shopping

List all your monthly inflows (income) and outflows – outflows includes living expenditure, loan repayments, contribution to investments.  Be honest while doing this. The surplus is what you can afford for monthly mortgage repayments.  However, you need to be aware that there are several associated costs while availing a mortgage that are either one-off or recurring.

Then go shopping for the best mortgage you can find.  Plan to spend quite a bit of time on the phone, visiting the websites or offices of mortgage providers and asking for rates and making comparisons. Some websites or magazines may also provide comparison tables of various mortgage providers. Alternatively, you can avail the services of an independent mortgage consultant.

Ensure that mortgage provider will provide financing to cover all of your potential needs which may include:
•    Purchase a ready property
•    Purchase a property under construction also known as off-plan development
•    Buy a plot of land and construct

You might want ask your relatives or friends about their experiences with mortgage providers.  Many a time it is better to deal with an institution which provides good customer service, rather than attempt to get the best terms.

You might also want to check the time between application submission and approval of financing.

While shopping for a mortgage also check out for various associated costs which are one-off. These may include an application fee, valuation fee, credit check fee, arrangement fee, legal fee, mortgage registration fee, mortgage release fee, prepayment or early settlement fee etc.

Several regulators insist disclosure of APR (Annualized Percentage Rate) by financial institutions which takes into consideration mortgage interest rate and fees charged on the borrowing. In simple terms, lowest APR is better for the borrower. However, you cannot solely rely on APR advertised as there may be some costs excluded by the mortgage provider for this calculation.  

Most of the mortgage providers require life insurance coverage on the customer with some seeking additional cover for disability, critical illness etc. and property insurance on the security (property).  Such associated costs are normally recurring throughout the term of mortgage finance.

 Tip 2: Consider which mortgage option will work best

You can consider both conventional and Islamic mortgages – non-Muslims are equally eligible for an Islamic mortgage.

A conventional mortgage is based on interest whereas an Islamic mortgage is quite different. The mortgage provider buys the asset and then either sells or leases it (with an eventual transfer of ownership) to the customer.

You also need to consider whether a fixed rate or variable rate mortgage suits your requirement.  In a fixed rate mortgage, your monthly instalment remains fixed throughout the tenure of financing.  If you choose this, you may not benefit from any decline in rates in the market (unless you wish to refinance).  However, you will benefit from any increase in rates in the market as your mortgage rate will continue to remain at the same rate.  

In a variable rate mortgage, the monthly instalment will vary depending on the frequency of rate change by the mortgage provider. You will benefit, if market rates decline as the mortgage provider will revise the rate (subject to basis of revision).  However, if market rates increase, then your mortgage rates and repayments will also increase.  Ensure you are able to afford the mortgage when interest rates increase – as a rule of thumb consider rate increase of 3% on your mortgage instalment.

You may want to check the basis of interest calculation. There are many variations of mortgage products and interest calculations which must be carefully considered.

Tip 3: Decide what property your mortgage will allow you to purchase

You can approach a mortgage provider for pre-approval to find out your mortgage eligibility. Based on this, you can choose your dream home.  

The most important aspect of mortgage financing is the finance to value ratio (also known as loan to value ratio in conventional banking terms). This ratio is calculated by dividing the amount of mortgage finance against the value of the property.  Normally mortgage providers provide up to 80% of the value of the property (in other words your equity will be 20%).  Mortgage providers use this ratio to indicate the risk of providing a mortgage and may vary this depending on customer risk profile.  Ensure that you have sufficient savings and investments to tap into for making your equity contribution (also known as down payment).

You must bear in mind that value of the property arrived by the mortgage provider’s independent valuer may be different from the price you have agreed with the seller.  Should valuation be lower than the price agreed, the mortgage provider would compute eligibility based on valuation, resulting in higher equity contribution. .

Also ensure that you have built up a separate contingency fund that covers at least 6 months of your outflows (as a rule of thumb).  Do not dip into this contingency fund to make your down payment!

Tip 4: Check that you meet the eligibility criteria

Eligibility criteria may include age, income, employment term, residency, debt burden ratio (your monthly financial obligations to monthly income must not exceed a certain percentage). If you are on a low income, ask if you can apply for a joint mortgage to meet income criteria. Ensure that your mortgage provider allows joint financing and if so how many applicants can enhance the eligibility.  Also ascertain that the mortgage provider provides financing to self-employed (business).

Tip 5: Mortgage application process

Once you have decided on the mortgage provider and type of finance you want, it is time prepare your formal application. So immediately start collecting all documents required by the mortgage provider including employment letter, salary slip, 6 months bank statements and property details.  A checklist of documents from your mortgage provider will be useful.  

Be honest with your mortgage provider and submit all relevant documents in one go! As a customer, the waiting time from application to approval is an anxious one, especially if there are some questions over your qualification. Delay in approval may also result in losing your dream home or renegotiating with the seller or developer.

You also need to understand what the mortgage provider will be doing during this period.  Credit assessment will be carried out along with a credit bureau check, and the property will be valued to ensure it is worth at least as much as you agreed to pay for.  Credit assessment would normally include an interview with you to seek information about how much you spend on groceries, eating out, grooming, travel, communication, medical, pet care, child care etc. and ascertain information about number of dependants, likely increase in family size, plans of leaving job and becoming self-employed etc., in order to assess eligibility and affordability.

You can use the services of an independent mortgage advisor to ensure prior to application that you stand a reasonably good chance with the chosen mortgage provider.

Tip 6:  Ask questions about what happens if you want to pay off your finance early or miss payments due to unforeseen circumstances.

Ask if early repayment is possible. There may be a penalty for early repayment of all or part of your finance.  Penalties may vary amongst mortgage providers depending on whether you are settling your finance early out of your own funds or you are moving to another mortgage provider!  The world over, customers do not continue with the mortgage for its entire life (tenor).  This is due to several reasons – over time income levels increase and the extra cash can be used to settle the mortgage, the home is sold for a number of reasons, or the home is refinanced through another institution.

Also check with your mortgage provider what happens if you miss an instalment payment due to some unforeseen circumstances and whether any penalty fee and interest would be levied for missing a payment.  

Some sound closing advice!

Pay off your mortgage with money that would otherwise go into a savings account.  For example, if your bank is providing 1% on your savings and the mortgage rate is 5%, then reducing the mortgage is much better!

Refinance a high rate mortgage that was arranged years ago taking advantage of the lower rate mortgages currently available. However, consider the cost of refinancing (i.e. cost of closing out with one mortgage provider and cost of availing with another provider) as sometimes you may not save!

A mortgage is probably the biggest financial commitment you’ll ever make, so review your decision carefully.  If you don’t keep your financial commitment, you will lose your home!  

Last but not least, budget in your calculation for fees relating to buying a home such as brokerage fee, search fee, property registration fee and fees and costs relating to running a home such as home owners association fee, maintenance, government fees and taxes on your dream home.  

Disclaimer: Any of the opinions expressed in this article are my own and solely reflects my personal views in my individual capacity. Any comments left about this article by others represent their own personal views, and not my own or anyone related to me. I do not necessarily endorse their opinions by allowing inclusion of their comments on this article.

Author: R Lakshmanan
Designation: Founder and Managing Director
Organization: Pyramid Specialized Management Consulting
Email: Lakshmanan@pyramidsmc.com