Tips for choosing the right mortgage lender and product
- By admin
- August 25, 2019
Coauthored with Henri Bacha
Chief Commercial Officer
Abu Dhabi Finance PJSC
1.Buying cash to ‘avoid’ paying interest/profit
Firstly, unless you’re cash-rich (which most people in the current market aren’t), you’ll need to finance at least part of your property purchase. Yes, there is a cost associated with mortgaging a property (just as there is with financing of any type), however the good news is that financing your property allows you to leverage, which is important, especially for property investors. If you’re in the fortunate position to be able to fund the entire purchase of the property yourself, then more power to you! However, just because you can doesn’t mean you should. Financing your property means you can spread risk and diversify the mix of assets you hold.
Let’s take two examples to illustrate the point:
Let’s say we have two clients – Jack and Mohamed, who both buy a property for AED1 million. Jack pays cash, whereas Mohamed takes a mortgage and borrows 75% of the property value (AED750,000), with their down payment being AED250,000 (25% of the property value). Let’s say both properties appreciate by 10% (AED 100,000) in one year. For Jack, this equates to a return on investment (ROI) of 10%, however the ROI for Mohamed is 40%. Leverage provides an opportunity to profit from the financial institution’s mortgage to you, and typically increases the effective ROI by up to five times.
Continuing with the above example, let’s say both Jack and Mohamed have AED1 million to invest. Jack uses the full amount to purchase an AED1 million property, whereas Mohamed only uses AED250,000. Mohamed is then free to invest the remaining AED750,000 in other asset classes including sukuks, halal shares, commodities etc. and/or keep some in cash. Jack, however, has put all his cash (and risk) into one property, and so is entirely dependent on just one asset.
TIP1: If you are an end user, then another way of looking at the amount of interest (or profit for Islamic financing) that you are paying is by comparing it with the amount of rent you pay to your landlord each month.
TIP2: Avoid putting all your eggs in one basket if you can and remember – many financial advisors recommend you hold at least six months’ salary in a low risk, easy access deposit account for emergency situations before making other longer term investments.
2.Not borrowing the right amount for you
You may find that you are approved for a higher Loan-To-Value* (LTV), however this doesn’t necessarily mean you should take it. Borrowing more than you can afford will quickly lead to being over-leveraged, which is a slippery slope. Missing monthly payments can result in penalties and late payment charges, legal action and even losing the property.
Similarly, just because you have a large amount of money saved up, it doesn’t necessarily mean you should use all of it as a down payment. You want to avoid leaving yourself short each month, whilst at the same time enjoy the benefits of leverage mentioned above. It’s always handy to have some spare funds put aside for a rainy day, and accessible in the event of an unexpected emergency.
The loan to value is the opposite of a down payment. It is the loan amount that the lender is prepared to give you to help buy your property. The maximum loan amount you can borrow in the UAE is determined by a number of factors including your age and nationality, the intended use of the property (i.e. end use vs. investment) and the actual property in question.
TIP1: If you feel that you’re being pushed to take out the maximum loan amount even though you don’t need to or didn’t ask for it then stop and consider. Make sure you speak with a qualified mortgage specialist from a responsible lender who can help advise the best option based on your current and future requirements.
TIP2: Make a budget plan before you decide on the size of mortgage repayment you can afford and remember that mortgage payments can go up as well as down over time.
3.Choosing the wrong rate because the headline advertised looks ‘cheaper’
It can often seem appealing to go with the lowest rate on offer, however watch out for promotional rates designed to get you hooked. Most people won’t be able to qualify for the lowest ‘teaser’ rates which lenders advertise on billboards in flashing lights, as the vast majority of buyers won’t meet the qualification criteria. Even if you’re one of the lucky ones that do, these introductory offers are often followed by much higher rates coupled with contracts that are difficult and expensive to break.
TIP: If in doubt, seek advice from a qualified professional and remember – if it sounds too good to be true, it probably is!
4.Choosing the wrong rate structure for your circumstances
Interest/profit rates vary between lenders, and also come in the form of variable and fixed rates.
Variable rates are linked to the prevailing market interest rate charges and so can go up or down along with your monthly repayments. In the UAE, the market interest rate is referred to as the EIBOR – Emirates Interbank Offered Rate, which fluctuates largely in line with its counterpart in the U.S., the Federal Funds Rate. Depending on the current economic climate, sentiment can be that rates are likely to increase, decrease or stay relatively flat, and so by taking a variable rate, your mortgage rate is effectively aligned with how you think market interest rates will change – up or down.
Fixed rates include an interest rate charged on the loan which remains fixed for the entire duration of the loan, irrespective of whether market interest rates go up or down, meaning your monthly repayments will remain the same during the entire duration of the loan. However as mentioned in point 4) most lenders in the UAE offer a fixed rate for an introductory duration only (promotion for up to five years typically) and thereafter the rates revert to a variable rate which has the potential to increase your monthly repayments considerably overnight.
Before trying to second guess the economy, it’s important to decide what you can (and more importantly can’t) manage, and what’s most important to you. If you have an absolute maximum amount that you can pay each month, and your monthly payments are likely to be close to this, then chances are a variable rate isn’t for you as this amount could increase if rates go up, and so a fixed rate is probably the best option.
Similarly, if you have a great deal of flexibility and so can afford to pay well above what your monthly payments are likely to be, and you’re confident that rates are likely to go down or at worst stay flat, then a variable rate could be more desirable than a fixed rate.
TIP: Never forget to consider what your rate will be after the promotional period ends and how it will affect your monthly repayment capabilities.
5.Not starting with your credit score first
Your credit score is one of the first things a potential lender will look at. Moreover, not only can it dictate the competitiveness of the loan you’re offered (interest rate, LTV etc.), but whether or not you qualify for a loan at all.
With this in mind, it’s always best to check your credit score before applying for a loan of any kind, and ensuring your finances are in order to maximise your chances of obtaining the best score before applying. Profile errors are not uncommon due to issues like having outdated and/or incorrect information against your profile, and so make sure you perform a thorough check to make sure everything is correct before you apply.
TIP: Your credit score should be readily available online in most countries, either free of charge or for a nominal cost. If you’re based in the UAE, then Al Etihad Credit Bureau (AECB) is available via the following link https://aecb.gov.ae/home, and have recently launched a new mobile app to make the process as user friendly as possible.
6.Getting prequalified instead of pre-approved
This is also a big help when it comes to the property purchase itself.
A lot of lenders will boast about how quick and easy it is to become pre-qualified with them, and there’s a reason for this. All a pre-qualification requires is minimal information from the potential borrower. There is little-to-no validation done by the lender, and so a pre-qualification isn’t really factored in when deciding an applicant’s eligibility. In most instances, they aren’t worth the paper they’re written on.
Pre-approvals, however, require applicants to submit relevant financial documents coupled with the potential lender running credit checks and eligibility tests. In markets like the U.S., a lot of real estate agents will request pre-approvals before showing homes in order to ensure the prospective buyer is eligible.
TIP: It’s definitely worth putting in the extra time and effort required to get a pre-approval, as this will end up saving you time, effort and probably money in the long run.
7.Not performing the proper conveyancing
Another one to factor in at the start of the property investment journey.
Buying a property (especially for the first time) is often a lot more complex and time-consuming than most people think. Don’t put a deposit down or even apply for a mortgage until you make sure that all searches and checks have been made related to the property – in particular no un-approved modifications have been made, no outstanding service charges or other developer fees etc. You can do this yourself or hire a reputable law firm to do it for you.
TIP: Don’t rely on your real estate agent or your mortgage provider to do it as it isn’t their responsibility.
8.Choosing the wrong lender
Don’t underestimate the value in shopping around for the best lender for your requirements. Previously, this may have negatively affected your credit score in some markets, however this is no longer the case.
Like most financial decisions, finding the right partner is critical. Every client is unique, and in turn has a different set of requirements which will dictate which lender/product is best suited to meet their requirements. In today’s day and age, more and more people are choosing brands based on their set of values as opposed to their product offering, and choosing a lender should be no different. Of course, there is a practical aspect in terms of meeting your requirements from a financial perspective, however you may find yourself in a situation where you qualify for a loan of a similar amount with a similar interest rate with more than 1 lender. So how do you choose which one is best?
Again, this depends on what’s important to you, however a company’s reputation is always a good starting point. It’s easy for a company to tell you how good they are themselves, but what do their customers have to say about them? Do they have client testimonials or online reviews? Do you know anyone who has a loan with them and can tell you first-hand if they’re happy with the service and transparency they receive?
TIP: You should also factor in whether or not you’re prepared to transfer your salary to your lender, as this is a requirement from most banks. If you don’t feel comfortable with this set up, or aren’t in a position to do this, then a bank may not be the right option for you.
9.Choosing the wrong repayment method because it ‘reduces’ your monthly payments
Yes, it’s true that your monthly repayments with an interest only loan will be less than a capital repayment set up, however there’s a good reason for this – you’re only paying back the interest on your loan.
In theory, interest-only also allows you to save more as you have more disposable income due to the lower monthly repayments. This could (again, in theory), allow you to profit from this additional saving, depending on if you choose to invest this and how.
That being said, interest-only is the more expensive option as, unlike with capital repayment, the amount of interest you owe doesn’t go down each year as you continue to pay interest on the full mortgage loan amount outstanding. With capital repayment, your loan amount shrinks each year as you’re continuously paying off your principal amount, and so the amount of interest reduces in line with the prevailing loan amount.
The biggest challenge with interest-only mortgages is that at the end of the loan period, you will still owe the lender the original amount you borrowed. Lower monthly repayments may seem like the best option in the short-term, however long-term you need to have a plan in place to pay back the full amount, or risk losing your home. The UAE Central Bank only allows interest-only mortgages for up to 5 years and only for select borrowers for this exact reason!
TIP: If you’re able to afford making the repayments for a capital repayment loan, this will be cheaper in the long run. It’s the simpler option which offers the most peace of mind as, as long as you continue to pay on time, you end up with your own, fully paid off asset and no loan.
10.Ignoring the true cost of ownership
Yes, it costs money to buy a house. Yes, it costs money to get a mortgage and yes, your monthly repayments will likely be the biggest ongoing cost associated with owning your property. They won’t, however, be the only ones and, unless you’ve owned your own property before, you probably won’t have factored these into your budget.
Many lenders and real estate agents won’t go into detail about the hidden, or less obvious costs associated with owning a property. These include ongoing upkeep of a property, routine and unexpected maintenance, utilities, tax and insurance. The bigger and older a property is, the higher these costs are likely to be.
TIP: When you’re factoring in the cost of buying a property and working out how much you can afford to pay each month for your mortgage, make sure you factor in a buffer for non-mortgage related costs, otherwise you could find yourself short each month and unable to pay for the property you/your family live in.