Factors banks consider before granting bonds

Posted On Saturday, 12 June 2004 02:00 Published by eProp Commercial Property News
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Factors banks consider before granting bonds

Saul GeffenWith home loan interest rates now at the bottom of their cycle and predicted to start rising within the next few months, many home owners may be considering fixing their rates and shopping around for the best deal they can get, as fixed rates are usually higher than variable rates. Potential home buyers, too, will want to ensure they get the best rate.

But many borrowers are not certain which factors the banks take into account in deciding whether to grant a home loan and in determining what discount they will allow from the base rate, which is currently 11.5%. Saul Geffen, MD of MortgageSA, says the lower the bank's risk in lending funds to a particular borrower, the better the rate it will offer.

The factors that banks take into consideration in calculating their risk include repayment-to-income ratio. This is the ratio between the monthly bond repayment and the buyer's income, and is one of the most important factors influencing the bank's decision to grant a home loan.

Geffen says as a rule, the buyer's bond repayments should not exceed 30% of their gross salary. Even if the potential borrower's earnings meet the required amount, the bank will still check their financial records to determine their monthly expenditure and ensure they will not be over-extending themselves. This will determine the size of the loan that will be approved and the lending rate offered. Another important consideration is the loan-to-value ratio.

This is the amount of equity (the deposit) that the buyer is willing to invest in the property, offset against the amount of the loan application. If the buyer is able to cover 20% or more of the value of the property, the bank is more willing to grant the highest rate concession than when the borrower has invested only 10%. It is therefore worth saving to put down a reasonable deposit, says Geffen, as being granted an interest rate concession of even half a point below the current prime rate will amount to a substantial saving over the 20-year term of a loan.

The size of the bond is also a factor. "Banks are more inclined to offer favourable rates to those purchasing higher priced properties because a higher-income client implies a lower risk to the bank," he says.

In addition, the lending institution will take into account whether the borrower is likely to repay the bond within two years, as the period of the loan impacts on its profitability. If the mortgage were to be fully repaid within a relatively short time, the bank's return would be much lower. In processing a home loan, the bank will also check the credit history of a potential buyer. Geffen therefore advises buyers to assess their current credit situation before applying for a loan, looking at their outstanding debts to see how this will impact on their monthly bond repayments. The bank will also factor in the type of bond granted when offering a rate concession.

To meet the widely differing needs of buyers, banks have developed home loan products with diverse features and benefits. These include maternity benefits that offer borrowers a home loan repayment "holiday" while paying off expenses relating to the birth of a baby; bonds with costs included; buy-to-let bonds; access bonds ;and fixed-term bonds. A first-time buyer taking out a bond that covers all transfer and bond costs, for example, is less likely to obtain a preferential rate, as the bank's security risk is higher. The bank will also assess the property to ensure that it is a worthwhile investment.

Banks are more willing to grant a home loan for a property that is likely increase in value over the term of the loan, says Geffen.

They will take into account location - whether the area is earmarked for growth - as well as whether it is the type of property for which there will be continued demand. Potential purchasers who wish to obtain a home loan are therefore advised to assess the property and its potential increase in value before applying to the bank. Geffen points out that there are market f actors that are beyond the buyers control.

The prevailing repo rate, for example, affects the concession that banks will grant, as this ultimately affects their profit margins. In times of low interest rates, margins are tighter and the rate of concession is usually lower, he says. To ensure that they get the best rate, the potential borrower must shop around and negotiate with the various banks, taking their personal criteria and all these factors into account, says Geffen. The simplest and most convenient way of doing so is through the services of a mortgage originator. Mortgage origination consultants are familiar with the home loan products of all the banks and specialise in negotiating the best package on behalf of each borrower.

This service is free to the consumer as the banks pay the origination companies for their services.

Last modified on Sunday, 25 May 2014 20:49

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