Check risk appetite before deciding on home loan

When it comes to buying property, many of us opt for home loans from banks or mortgage finance firms.

But there is one vexing question many of the home loan seekers often come to face –whether to go for floating interest rate home loan or fixed rate home loan?

While for some, a fixed rate means a lasting piece of mind, others like to flow with the floating rates.

But how many of us rightly decide which rate is suitable for us and what are the parameters that must be considered before laying hands on either of the home loan options?

Is one better than another?

One of the most common questions prospective borrowers face is whether one interest structure score over the other.

It's natural to ask, but it's a difficult choice indeed, and a never-ending debate as each has its own inherent benefits and drawbacks. It's as good as asking which one is better – a 32-inch LCD television or a 10-megapixel snazzy smartphone?

Whatever be the case, one of the prime factors in determining which rate to go for would depend on borrower's needs, his risk appetite, interest rate movements, his ability to repay and so on.

This really depends on the individuals themselves, said Robert Elliott, Business Development Manager, John Charcol Middle East, Dubai.

He said some fixed products are only available for certain developments and will only be fixed for a short term. Variable rates are at an all-time low but have the ability to adjust up or down with the market. To choose one type of product without seeing a clear picture of our client's goals, eligibility and location of interest makes it almost impossible to pick one over the other.

Further, he said, fixed home loan rates in the UAE are not fixed for a long term and most only last two to five years. So, to choose one over the other really depends on the client, location and expectations. R Lakshmanan, CEO, Sakana Holistic Housing Solutions, Bahrain, said it all depends on how much is the rate, how long it is fixed, what are the conditions or penalties for switching over from fixed to variable rate and vice versa, are there any fees and charges to avail fixed rate.

Comparison should be made on all these factors to avail fixed or floating.

The benefit of a fixed rate home loan is that the installment amount remains constant since the interest rate is fixed for a particular tenor, thus allowing the customer to budget their financials over a longer period of time.

The possible disadvantage to this is in situations where the rates drop, wherein such customers will not benefit from this reduction since they are on fixed rate loans.

Floating interest rate home loans are typically comprised of a base rate and margin. The upside of this type of pricing is the reduction in instalment payments that the customer will benefit from when interest rates reduce, said Shekhar Krishnamurthy, Head (Retail Assets and Liabilities), Emirates NBD.

Balancing act

In the UAE, most of the mortgage lenders generally benchmark their floating interest rates against the Eibor (Emirates Interbank Offered Rate). However, experts say most of the banks are now benchmarking their rates against internal benchmark rate such as prime lending rate, base lending rate etc.

"We are now seeing most banks use their own internal index that will determine their offered variable rates and you must check with your lender what type of index they use, and when they re-evaluate or adjust their index. This can be made monthly, quarterly etc. Although most lenders will use their own index they will however most likely still follow the trends of the Eibor rate," said Elliott of John Charcol Middle East.

However, as Krishnamurthy of Emirates NBD said: "In the UAE, fixed and floating rates are set by each lender based on its pricing methodology and cost of funds, etc.

"When it comes to home loans, fixed rates are usually higher than floating rates due to the risk associated with longer-term pricing.

The spread between fixed and floating rates may not remain constant, especially for a home loan where the tenors are long. Lenders generally benchmark their floating interest rates based on what most accurately reflects their cost of funding.

"Therefore, it is up to the borrower to decide whether a fixed rate or a floating rate suits him better over the long run."

Further, as is commonly the case in many markets, a fixed rate loan generally comes at a higher price than floating loan products in the UAE. In the UAE market, fixed rates have always been at much higher than floating rates. Typically in the past you would see floating rates in the low seven per cent while fixed rates top the scale at nine per cent to 10 per cent.

The reason fixed rates were benchmarked higher was due to the fact that lending to expats (resident and non-resident) was new in UAE. Banks did not want to offer low fixed rates in a maturing market while bearing all the risk if there was a chance things could go sour.

As the market is maturing and the industry is seeing how current problems are being played out, transparency is providing comfort. As a result we are seeing fixed rates enter into the market from time to time.

These may not be fixed for 25 or 30 years but over of a short-term fixed period, and it's good to see more aggressive and user-friendly products come into the market, Elliott of John Charcol Middle East, said.

Be ready for unexpected

This is especially true for floating rate borrowers who should be aware of unexpected market headwinds and be prepared to meet unforeseen circumstances such as increase in interest rates, etc, said experts.

It is always better to set aside extra savings for potential increase in rates.

Conversely, when rates are reducing better not to spend the reduction in installment – save for the rainy days, said Lakshmanan of Sakana Holistic Housing Solutions. Another factor for floating rate borrowers is to watch the movement of Eibor rate.

Besides, they also need to check on what basis the interest rate change will be done, what's its frequency and is the process transparent, etc, say experts.

As Steve Gregory, Managing Partner, Holborn Assets, Dubai, said, the advantage of a fixed rate is simply that you then have a known cost each month and that makes it easier to budget. The disadvantage is that rates are high in the UAE and cheaper elsewhere. So if rates fall in cost in the future and you have a fixed rate, you are going to miss out on lower rates on offer at the time.

On the other hand, if interest rates move up globally, as they probably will, then you could see the banks increasing the rates they charge on mortgage loans in the UAE.

Further, it's not always the case that fixed rate loans remain more expensive than floating loan products in the UAE, he said.

If banks perceive that interest rates will move down in the future, they will offer fixed rates that they can profit from when rates fall.

What if interest rate changes?

Many prospective home loan borrowers ask a very customary question – if the floating interest rates are reduced what options they can have?

Can they reduce the monthly installments or shorten their loan tenure? Conversely, if the rate increases, can they extend their tenure without disturbing the monthly outgoings?

This depends on the mortgage lender's policy, say experts.

Extensions will have constraints considering the retirement age of the customer and the life insurance availability, said R Lakshmanan CEO of Sakana Holistic Housing Solutions.

We advise our customers to be more diligent in assessing their repayment capacity taking into account that instalments will vary based on prevailing rates at the revision cycles.

Borrowers who are opting for floating rate interest need to budget for a possible increase in monthly payments due to a rise in interest rates.

In most cases, if interest rates reduce, monthly instalments are correspondingly revised for the borrower, which benefits them, he said.

The tenure, however, is not normally automatically revised unless the customer requests for it, said Krishnamurthy of Emirates NBD.

Steve Gregory, Managing Partner, Holborn Assets, Dubai, said that generally, a borrower will be asked to pay less if interest rates reduce. However, he may be prevented from reducing his mortgage term by conditions in the mortgage loan agreement. Similarly, he would need to talk with his bank about extending the tenure of a mortgage, but the banks are not usually flexible, and most people have borrowed for the longest possible term when taking the loan in order to minimise costs.

Elliott of John Charcol said mortgage product will be based on many factors such as age, income, liabilities. Once the process of calculating your mortgage product is done, there is no way you can amend your policy.

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