TIPS TO CONSIDER WHEN CHOOSING TYPES OF MORTGAGES

Tips to consider when choosing types of mortgages

BY Beatrice Wacuka

Owning a home is one of the major

milestones an individual can achieve.

With it comes living security and an

opportunity to build equity. Finding a

property is one thing, and actually

making the purchase is another issue

all together. Unfortunately, given that

property ownership is overall capital

intensive, financing a purchase has

killed many home ownership dreams and

thus the need for a solid financing

plan. In this market, the main purchase

options include installment payment

plans, cash lump sum and mortgages. In

this article we focus on the mortgage

option.

To begin with, a mortgage is a debt

facility extended by a financial

institution-mortgage lender or bank, to

enable an individual purchase a home

or property. While it’s possible to

take out loans to cover the entire cost

of a home, it’s more common to secure

a loan for about 90% of the home’s

value. When choosing a mortgage,

borrowers mainly just focus on the

interest rate and fees you’ll be

charged. However, there is also need to

consider the types of mortgage loan

options available when making a

decision on the same. The two most

common types of mortgages are fixed-

rate and adjustable-rate (also known as

variable rate) mortgages.

Fixed-rate mortgages provide borrowers

with an established interest rate over

a set term of typically 10, 15, or 20

years (“initial period” of the loan).

With a fixed interest rate, the shorter

the term over which the borrower pays,

the higher the monthly payment.

Conversely, the longer the borrower

takes to pay, the smaller the monthly

repayment amount. However, the longer

it takes to repay the loan, the more

the borrower ultimately pays in

interest charges.

The greatest advantage of a fixed-rate

mortgage is that first, the borrower

can count on their monthly mortgage

payments being the same every month

throughout the life of their mortgage,

making it easier to set household

budgets and avoid any unexpected

additional charges from one month to

the next. Secondly, the borrower can

lock in lower rates if market interest

rates increase significantly, thus the

borrower doesn’t have to make higher

monthly payments. In addition, lenders

often compete with fixed rate specials.

On the downside, fixed rates often have

limits on how much you can raise

repayments or make extra payments

without paying charges. More so, if you

take a long term, there is a risk

floating rates may drop below your

fixed rate but you cannot benefit from

the drop. And finally, if you choose to

sell your property and/or break a

fixed loan you may be charged a ‘break

fee’.

Fixed-rate loans are ideal for buyers

who plan to stay put for many years. A

20-year fixed loan might give you

wiggle room to meet other financial

needs. However, if you have the

appetite for a little risk and the

resources and discipline to pay your

mortgage off faster, a 10-year fixed

loan can save you considerably on

interest and cut your repayment period

in half. In spite of that, it is

important to note that, within the

Kenyan mortgage market, the maximum

loan maturity period reported by the

Central Bank of Kenya was 20 years,

with the average period of time offered

by most lenders being 11.3 years as at

2019.

On the other hand, we have variable

rate mortgages also referred to as

adjustable rate mortgages. With this

type of mortgage, interest rates

usually change over the life of the

loan. In some cases, adjustable-rate

mortgages mostly have a fixed rate for

an initial period, but after that

period expires the rate fluctuates.

Increases in market rates and other

factors cause interest rates to

fluctuate, which changes the amount of

interest the borrower must pay, and,

therefore, changes the total monthly

payment due. With adjustable rate

mortgages, the interest rate is set to

be reviewed and adjusted at specific

times. For example, the rate may be

adjusted once a year or once every six

months depending on the mortgage

lender.

Some adjustable rate mortgages products

have a rate cap specifying that your

monthly mortgage payment cannot exceed

a certain amount. In that case, it is

important for a borrower to crunch the

numbers to ensure that they can

potentially handle any payment

increases up to that point. It is

advisable that one does not count on

being able to sell their home or

refinance their mortgage before their

mortgage resets because market

conditions and ones finances could

change.

On the upside, with the variable rate

mortgage, the borrower has more

flexibility to make changes without

penalty, such as paying off the loan

early or changing the loan term. Often,

the borrower will also enjoy a lower

fixed rate in the first few years of

homeownership as the rates tend to be

lower. Additionally, it’s easier to

consolidate other, more expensive debt

into floating rate loans by borrowing

more.

The primary risk with this type of

mortgages is that interest rates may

increase significantly over the life of

the loan, to a point where the

mortgage payments become so high that

they are difficult for the borrower to

meet. Significant rate increases may

even lead to default and the borrower

losing the home through foreclosure.

Adjustable rate mortgages are a solid

option if the borrower intends to

refinance before the loan resets, as

the interest rates for these mortgages

tend to be lower than fixed rates in

the early years of repayment, so one

could potentially save significantly on

interest payments in the initial years

of homeownership.

In conclusion, choosing the mortgage

loan that’s best for a borrower’s

situation relies primarily on their

financial health: income, credit

history and score, employment, and

financial goals. Mortgage lenders can

help analyze ones finances to help

determine the best mortgage loan

products, and understand the

qualification requirements, which can

be complex. It is therefore important

to undertake an in-depth comparison of

the available deals focusing on all

aspects of the loans; the type, minimum

requirements, applicable interest

rates, relevant fees, flexibility of

payments and exit penalties.