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Mortgage is becoming the preferred choice of real estate investors in the UAE, as a few lenders are still offering mortgage base rates as low as 2.5 per cent. And with the equitable real estate sale price, comparative high rental yields, flexible payment options, affordable development and the historic low mortgage rates, end users and investors are getting enticed to enter the market through bank finance. Currently, banks finance 75-80 per cent of the value of a property, which is to be paid with interest over a specific period of time. As it is prudent to do research on lenders, rates and financing options, it is helpful to understand how interest rate works and how to manage it.
The lender applies an amortisation structure to generate the repayment schedule, breaking down each payment into interest and principal. The monthly instalment is calculated based on the principal amount borrowed, interest rate and the total period of the loan. Each month a borrower pays back a portion of the principal plus the interest accrued for the month. The loan tenure also determines how much will be paid each month. Spreading out amortisation over maximal years (up to 25 years) generally result in lesser monthly payments. Mortgage repayment is usually calculated using reducing balance methodology across the tenure. At the start of a loan settlement cycle, the principal gets paid gradually as most of the payment is applied to the interest component, however, during the course of the mortgage repayment, the principle would have a larger proportion of the monthly instalment.
To calculate a borrower’s loan eligibility, the lender will review the credit report, monthly gross income and the amount the borrower is capable of paying for down payment (a minimum of 25 per cent). This will help determine the debt-to-income ratio. Typically, the total debt should be around 30-35 per cent of a borrower’s income.
Fixed rate and adjustable rate
Banks offer two types of mortgage loans: fixed rate (when interest rate does not change during the defined tenure) and adjustable rate (also known as a variable rate or tracker loan, where interest rate will change under well-defined preconditions). Borrowers face a tough decision on this, but depending on market conditions, a mortgagor needs to understand and calculate risks when choosing between adjustable-rate and fixed-rate mortgage. When interest rate is expected to hike or change frequently, a fixed-rate mortgage is recommended. But when rates are dwindling, borrowers should pick variable mortgage rate. Predominantly, banks offer lower interest rates in the first few years, but then rates change frequently and banks make adjustments accordingly to reflect the current market conditions. Most adjustable rate terms have a defined margin on how much the interest rate may swing, as well as howoften it can be revised. In the current market trend, most banks are offering one, two or three years fixed rate, then have adjustable rates in repayment structure. Your mortgage repayment is influenced by the current and future financial outlining and also on how long you plan to stay in the property.
Here is how these work in mortgage. A Dh1-million, fixed-rate mortgage for 25 years (300 monthly payments) at an interest rate of 3.99 per cent will have a monthly payment of approximately Dh5,272. If calculated using adjustable rate mortgage, we need to readjust the repayment schedule based on the bank margin and variable component of EIBOR on the specified term. Hence, the monthly installment would vary across the tenure of the loan. Considering the historic low rate and the movement in the worldwide market, it is prudent to lock in a fixed-rate mortgage.
When you step onto the property ladder, there are supplementary factors to be considered that could significantly add to the purchase price. On average one pays around 8 per cent on top of the property price for government fees, title deed charges, NOC fee, trustee charges, life and property insurance, mortgage processing fee, market valuation fee, pre-approval fee and mortgage application fees.
Home ownership requires long-term financial planning. We thus advise borrowers to take advantage of low and fixed-rate terms, as very soon banks will try to squeeze a little more from the borrowers. So be perceptive and act smart.
Source: Property Weekly