Opinion: Interest rates - where to now?

PWMohanad Alwadiya

It’s no secret that cash purchases now account for between 65 per cent and 75 per cent of all property purchases in Dubai. This is definitely high by world standards. Mortgage growth in the emirate ballooned in 2007 when mortgages were being used as a source of leveraged investment financing.

Thankfully, this practice has been curtailed significantly, but it does highlight how much additional capital could be available once banks are confident in their new prudent lending practices, buyers adjust to the new loan-to-value and credit exposure regulations and everybody accepts that the current cooling down of the market is just part of the normal cycle that is typical of the industry.

In more mature markets, banks play an incredibly important role in determining the inflation, stagnation or deflation of home prices largely by the mortgage rates that they offer.

In markets such as Australia, the dependence of the major banks’ profitability and bank shareholder returns are closely linked to the share of the mortgage market that the bank can capture. The interdependence between the banks and the industry is very strong.

It is no secret that there has been a mortgage war going on in Dubai. Mortgage rates of 3.49 per cent fixed for two years, no exit fees, no bank arranging fees, repayment holiday periods, all claiming to be the best deal in the market. So clearly, banks are interested in mortgages.

Rates of the future
However, it begs the question that every prospective mortgagor, investor and industry professional needs to ask: what type of interest rate will banks be offering in the future? There is no doubt that paying 3.49 per cent interest for two years is an attractive proposition, but given that most mortgagors will be paying off their home for at least 20 years, careful thought must be given as to the effects of rising interest rates, inflation, lifestyle changes and changing personal expenditure patterns.

It is not a question of if interest rates will rise, but when. As the world slowly returns to a semblance of reasonable economic growth, inflation, important for economic growth and sought by every economy, will become a factor. A modicum of inflation is desirable (the US Federal Reserve is doggedly chasing 2 per cent), however, as inflationary momentum accelerates, interest rates will be increased, keeping inflation under control as excessive inflation is highly undesirable for all of us.

So what happens when the attractive 3.49 per cent interest rate enjoyed today is replaced with a significantly higher rate after a few years, requiring increased mortgage payments to cover the interest rate hike?

Consider the following simple example. A 20-year mortgage for Dh2 million with an interest rate of 3.99 per cent will require a monthly payment of Dh12,109. An increase in interest rates to 5.99 per cent on the same mortgage would require a significant increase of approximately 18 per cent on the monthly payment. For the purpose of reflection, this is what happened to many mortgages in the US leading up to 2008.

The inevitable rapid growth in mortgagor defaults became a major factor in the bursting of the real estate bubble that had developed over the preceding six years and the eventual onset of the global financial crisis.

So careful analysis is required as mortgagors need to envisage their economic circumstances at least two years into the future. The big question is this: Given your projected earning capability and desired lifestyle, what mortgage payment increase will be financially feasible and acceptable to you in two years?

There are several factors at play here. First, estimating a projected earning capability can be a little daunting. We all hope to progress rapidly in our professional (aka financial) pursuits, but there are generally more people disappointed than delighted with their achievements. Notwithstanding the latest reports of 5 per cent salary increases for Dubai employees next year, history has shown that salary increases generally tend to lag behind the cost of living, so conservatism in estimating future cash flows is a must.

Then there is lifestyle. Is there a new baby planned in the near future? A new car? What effect will significant family or lifestyle events have on disposable income? Are there existing children who will need to start school in that time frame? All these events will have an effect on disposable income and thereby decrease the financial flexibility to address interest rate shocks.

Is it acceptable?
And finally, what is financially feasible may not be acceptable. How much sacrifice are you and your partner willing to make to service your mortgage? What are you willing to do without and what lifestyle changes are you prepared to make? Once again, being honest with oneself is paramount.

So, notwithstanding economic recoveries and resurgent markets, cautious financial planning based upon realism and self honesty is key when planning the purchase of your dream home. Your future depends on it.

Source: Mohanad Alwadiya, Special to Property Weekly
Managing Director of Harbor Real Estate and advisory board member and instructor at the Dubai Real Estate Institute, the official training and certification arm of the Dubai Land Department.

Al Nisr Publishing accepts no liability for the views or opinions expressed in this article, or for the consequences of any actions taken on the basis of the information provided.

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