Mortgages: Both Sides of the Medal

Faina Filina, exclusive for Ipocredit.Ru

Dmitry Leus: “If income allows it, I advise early mortgage repayment”

Buying a property is certainly not a situation when one should “jump in feet first”, in particular when it comes to taking out a mortgage. Which are the main points potential mortgage buyers should keep in mind?

 Suppose you decided to improve your housing situation: buy your own flat, move from a two-bedroom flat into a three-bedroom apartment, or move closer to the centre. The decision is taken…, but you cannot afford it. That is the exact moment when the concept of the mortgage comes to mind.

Some view mortgages as a form of modern enslavement but, honestly, saving millions is a difficult task for common mortals. Of course, mortgages have their advantages and disadvantages. There are a lot of small but important details borrowers should know in order to avoid trouble. One thing is clear — on your road to the paradise of home owners, do not stop at the first bank, and do not blindly agree to all conditions.

Take it or leave it

In Summer 2011, the mortgage market was very attractive for borrowers — thousands of offers, promotions, discounts, as lenders competed to win over customers.

Then came fears over the possibility of a “second wave” of the crisis. And things on the mortgage market began to change…

Currently, banks have started to raise interest rates on loans, including mortgages. For the moment the increase is still small, not over 1 percent, but that may change…

“In the current macroeconomic environment, new home owners wishing to apply for a mortgage should act quickly”, recommends the Chairman of Bank Zapadny, Dmitry Leus, justifying his position by expert opinion stating that interest rates are not expected to fall in the short to mid term. Quite the opposite: “in fact, in crisis situations, banks not only tend to increase interest rates, but also to adopt more restrictive mortgage approval processes”, explains the banking specialist. “In other words, client applications run a greater risk of being rejected, as assumptions are tested against a more pessimistic scenario, and documentary evidence requirements with regard to client data such as income history undergo higher scrutiny”, says Dmitry Leus.

“Many banks have begun to tighten credit conditions. This is the result of increased costs of credit resources. Better to jump on the bandwagon of low rates right now”, equally confirms Sergei Arzyantsev, Head of Mortgage Lending at Nomos Bank.

Decades, not years

When taking the decision to apply for a mortgage, the first thing to assess is one’s own financial strength. A maximum of prudence should be used, as mortgages are serviced over decades.

However, according to the Head of Mortgage and Consumer Lending at SMP Bank, Natalia Konyakhina, the loan’s term can be determined by the borrower himself. “Basically, people take out a mortgage for 10 to 15 years and repay within 5 to 7 years”, she says. “The longer the term, the greater the interest premium paid to the bank, warns Dmitry Leus from Bank Zapadny. “If income allows it, I advise early mortgage repayment”.

When making a decision about buying a property with a mortgage, it is important not to be frightened. In fact, for most people mortgages are the only way to turn into home owners, without having to save up for years (and see these savings finally eroded by inflation). According to Dmitry Leus, mortgages are a time-tested, relatively comfortable, streamlined, and affordable tool to solve the housing question.

On the other hand, it would be misguided to take mortgages lightly. Repayment is mandatory and must be made on a regular basis, unless your home be repossessed. Accordingly, it is necessary to calculate what portion of family income can comfortably be spent on repayment — without living on bread and water.

What it takes

While deciding on a mortgage, it is not only the borrower who assesses his financial capacities. So does the bank…

“The borrower must have a stable job”, argues Natalia Konyakhina. It is a good sign if the borrower already owns an apartment, a secondary residence, a car, or any other assets of value. Equally important is a positive credit history”.

“An official proof of income is an icebreaker for most banks”, says Dmitry Leus. “However, even the existence of historical income figures as, for example, evidenced in an applicant’s official tax declaration, cannot guarantee that such income will always be available over the mortgage’s life”. Therefore banks are more and more often using internal questionnaires to document the income history of their potential clients. As a consequence, interest rates may be slightly higher.

The average borrower’s age is between 27 and 45, but the range may be wider. “Our applicants tend to be between 21 and 60 years old”, says Dmitry Leus.

Better not bet

Another important aspect worth consideration is the loan currency. “It is better to take out a mortgage in the currency of the borrower’s income, in order to avoid increased mortgage costs due to exchange rate fluctuations”, says Natalya Konyakhina.

“For borrowers with income in Russian roubles, the mortgage should, of course, only be taken in roubles”, agrees Sergey Arzyantsev. “It is nonsense to take a mortgage loan denominated in dollars/euros, thereby entering into a bet on whether the dollar/euro currency pair will weaken against the rouble”. “If the borrower’s main income is in roubles, the mortgage should definitely be in roubles too”, confirms Dmitry Leus from Bank Zapadny. “This will at least help avoid taking an unnecessary currency risk”. According to Dmitry Leus, it is important not to be naive about floating rate mortgage proposals, which are normally linked to such instruments as the MosPrime (Moscow Prime Offered Rate), or the Libor (London Interbank Offered Rate), or to the Central Bank’s own refinancing rate“. I am very cautious with regard to this option”, says Dmitry Leus. “Interest rates can only go up right now and, in general, when it comes to mortgages, exchange rate uncertainty is an undesirable additional burden for the borrower”.

On the other hand, by making a simple calculation, one can see that floating rate offers can look quite attractive. For example, one bank offers 9.75% for the first five years, and 4.5% above MosPrime (today at 6.64%) during the remaining years.

A comfortable bank

When choosing a mortgage provider, it is necessary to pay attention to some minor, but nonetheless important details. “It is better to take out a mortgage at a stable bank with a good reputation, where mortgage lending is part of core business”, says Natalya Konyakhina from SMP Bank.

“First of all, you need to check in which currency the bank is willing to offer you a mortgage”, adds Dmitry Leus. “Then compare interest rates and clarify the requirements with regard to the property to be purchased”.

According to Sergei Arzyantsev from Nomos Bank, one needs to pay attention not only to interest rates, but also to a bank’s possibility to mortgage various non standard activities such as redevelopments, or real estates which were owned for less than three years by their previous owner.

“One has also to consider whether the bank takes into account revenue sources in addition to the official tax declaration of the main borrower, and whether the banks is ready to accept co-borrowers (guarantors) different from the main borrower and his spouse. This can be of key importance, for example when documented income is short of 5000 roubles, in order to buy the house of one’s dreams.

Meanwhile, a bank’s quality of service is also important. Always pay attention to the level of service on the first visit to a bank. A very good sign is when a bank assigns a personal manager to their new client right away. At least it prevents you from telling the same story over and over to different employees. The package of documents required for a mortgage application is quite big. It is therefore helpful when a single banker takes ownership for the coordination of the entire process.

In addition, borrowers should remember that they will have to regularly visit the bank over many years. It is important that there be no queues and that the credit institution’s opening hours be flexible. In Russia, there are still banks that close at 6pm which is surprising, given that most clients finish work at the same time or later.

According to Sergei Arzyantsev, it is also important to get clarity on the bank’s overall fee structure, including arrangement and other one-off fees payable upon loan draw down.

Payback time

There are two ways of repaying a mortgage loan — full repayment (capital and interest on a monthly basis) and interest-only (with a final lump sum payment at maturity).

An interest-only mortgage, as its name indicates, implies equal interest payments every month, and a lump sum principal repayment at the end of the mortgage term. On the other hand, a repayment mortgage implies interest and principal payments each month. Thus, the amount is typically higher at the beginning of the mortgage term. Over time, these payments decrease due to the fact that interest is charged on a smaller debt.

Sergei Arzyantsev from Nomos Bank believes that the full repayment strategy is somewhat of a marketing trick used by lenders to be able to point to decreasing mortgage payments and, allegedly, higher savings for borrowers. In fact, this offer is by no means better for borrowers, and sometimes even less favourable, as the real value of money remains the same.

Dmitry Leus from Bank Zapadny takes a different view and gives the following example: suppose you borrowed 1 million roubles for 10 years at a rate of 11.25% p.a. In the scenario of an interest-only mortgage, 13 854 roubles are due every month during the entire mortgage period. The structure of payments will change as follows: in the first month, the principal repayment will amount to 4607 roubles whereas interest amounts are 9247 roubles — in the last month 27 486 roubles and and 271 roubles respectively. Over the entire mortgage term, aggregate interest payments will have amounted to 676 412 roubles (not including one-off charges, insurance, and monthly administrative fees).

In case of a full repayment scheme, the first repayment will amount to 8333 roubles, and interest is 9246 roubles. The total amount of the payment will be higher than in the first example – 17 579 roubles. Then, the amount of debt will be reduced by 8333 roubles, and so will be the interest payments: 17 805 roubles in the second month, and 17 703 roubles in the third month, and so on. In the last month, the total payment amount will be 8408 roubles, of which 8333 in repayment and 74 in interest. Over the entire mortgage term, total interest payments will have amounted to only 566 893 roubles (not including one-off charges, insurance, and monthly administrative fees).

Thus, in a scenario of constant interest rates, total interest payments for a repayment mortgage will be 109 519 roubles lower than for an interest-only mortgage. Under such assumptions, repayment mortgages seem to be more favourable for borrowers.

According to Sergei Arzyantsev, the full repayment strategy has only one caveat. When repayment mortgages are sold to customers — and payments are claimed to be lower than for interest-only mortgages — the option of early repayment under interest-only mortgages is completely passed over in silence. In reality, no one prevents interest-only borrowers to down-pay as frequently as under a full repayment scenario. Under such a hypothesis, total interest payments are absolutely identical.

(All figures were correct at the time of writing).

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