If I’ve not mentioned it enough before, then I will just say it again. Buying a home is a significant decision especially if you are buying your first property.
I recommend for any new homebuyer is to first be sure of your budget, the target location and the type of property that fits your requirement. There is no need to hurry in buying your first property because I believe the biggest winner is the guy who scales best with their investment portfolio.
With that said, it is all about manoeuvring well in the real estate market and we’ve covered quite a bit on getting started as a first time homebuyer. Below are some easy reads on shopping for your home and getting ready for the homeownership experience.
- 10 signs that you’re ready to be a proud homeowner
- Preparing the necessary cash to buy your first home
- Location should be your first consideration, not price
- 4 key factors to consider when shopping for a property
Now that you have found the property of your dream, it is all about looking for ways to finance the purchase. Being a big transaction, not many of us can afford to pay it fully with cash.
Hence, it is common for many of us to borrow a mortgage loan from a banking institution, be it a local or overseas bank to finance the property.
In my journey, I found some of the terms used in the mortgage loan to be rather confusing. Being a first-time homebuyer I was at that time, it would have been good if there is a glossary to help me run through the loan offer quickly, understanding the jargons bank use in their offer to finance our property.
With that said, here is my effort in putting together a list of what you will potentially see in your loan offer.
Fun fact: I was running through the loan offer I received as I put together this list.
1. What is a term loan?
In most mortgage loan offers, it is common for you to see the word term loan used explicitly.
A term loan is a credit facility from a bank for a specified amount with a fixed repayment duration. Corresponding to the fixed repayment duration, there is a repayment schedule with a pre-determined fixed or floating interest rate. Settling a term loan within the lock-in period will have penalty charges.
In Malaysia, the typical mortgage term loan is for 35 years (or up to 65 years old) with a pre-determined monthly instalment depending on the interest rate offered for the mortgage loan.
Having said that, there are generally 3 main types of mortgage term loan offered in Malaysia,
- Basic Term Loan
- Semi-Flexi Loan
- Full-Flexi Loan
I will not cover these types of term loans in full so do feel free to read on in this article where we explore the benefits and drawbacks for the different types of mortgage loans.
2. What is an interest rate?
The interest rate for a mortgage loan is the amount bank charges the borrower on top of the principal used to finance the purchase of a property. In Malaysia, mortgage loan has a floating interest rate that is dependent on the Overnight Policy Rate set by the Central Bank of Malaysia.
In simple words, the interest rate is how the bank earns money for lending you money to finance your home. If you have a mortgage loan of 3.5% interest rate per annum, the loan interest is calculated from the outstanding loan capital that you owe the bank.
If you think that the interest rate is straightforward, not quite.
There are actually three things you should understand about the interest rate,
- Overnight Policy Rate (OPR)
- Base Rate (BR)
- Prescribed Rate
a. What is the overnight policy rate (OPR)?
Like how banks loan money to us, the regular joes, to finance our homes. The bank needs to borrow money from the interbank market in order to finance any deficit due to an unexpected withdrawal demand.
To facilitate this interbank borrowing, the overnight policy rate (OPR) exists and is governed by the Central Bank of Malaysia.
The overnight policy rate (OPR) exists as the minimum interest rate charged within the interbank market. It is often used as the primary reference rate for all other credit facilities. Hence, when the OPR changes, the interest rates for mortgage loans is expected to change accordingly.
The overnight policy rate does not directly affect your mortgage loan interest rate but the change in OPR has a direct impact on your prescribed rate.
b. What is the base rate (BR)?
Slightly different from the overnight policy rate, the base rate is applicable between the Central Bank of Malaysia and the commercial banks we borrow our loans from.
The base rate is the interest rate applied by the Central Bank of Malaysia whenever the commercial loans take a loan from them. The base rate varies between banks depending on their lending effectiveness and is used as a reference rate by commercial banks as they extend loans to their customers.
Fun fact: it is easy to be confused between Base Lending Rate (BLR) and Base Rate (BR). There really is nothing much to explain other than to let you know that the Base Lending Rate (BLR) is obsolete and replaced by the new Base Rate (BR) system.
c. What is the prescribed rate?
If you look at things from a business perspective, essentially, the base rate is the interest rate Bank Negara Malaysia (BNM) charges the bank for a loan taken with the Ministry of Finance.
In other words, the base rate is their breakeven mark and if they are able to charge an interest rate higher than the base rate, that will be their earnings. By borrowing from BNM at 2.22% and lending it out at 3.0%, their gross earning from the loan offered is 0.78%.
So what is the prescribed rate?
The prescribed rate stated in mortgage loans offered by commercial banks is the additional interest rate charged on the base rate determined by the Central Bank of Malaysia. It also determines the potential earnings the bank may make by lending you the principal to finance your property.
d. How do I determine the interest rate of my mortgage loan and how does the OPR affect it?
In most loan offers from banks, the prescribed rate will be stated as BR plus 0.22% p.a.
This means that the profit margin the bank makes from the loan offered to you will forever stay at 0.22% p.a.
A scenario in study,
- Base Rate for bank : 2.63% p.a.
- Additional Rate by bank to you : 0.22% p.a.
- Applied Interest Rate on your mortgage loan : 2.85% p.a.
However, the Base Rate of the bank can change from time to time and is typically dependent on the Overnight Policy Rate (OPR). Assuming that the Central Bank of Malaysia decides to increase the Overnight Policy Rate by 0.25%, the base rate will be affected.
In a scenario where the Overnight Policy Rate increases by 0.25%,
- New Base Rate for bank : 2.88% p.a.
- Additional Rate by bank to you : 0.22% p.a. (to stay the same)
- Applied Interest Rate for your mortgage loan : 3.10% p.a.
3. What is a repayment period?
The repayment period for a mortgage loan is the period from the first monthly instalment payment to the final monthly instalment payment. The repayment period is often determined by the borrower and is limited to a maximum tenure of when the borrower is 65 years of age.
For younger homebuyers, it is common for financial institutions to offer a longer tenure on your mortgage loan. However, if you are borrowing money at the age of 50 years, chances are that the bank will only offer you a loan tenure of 15 years.
This is because banks deem an individual unable to work and generate a regular income if they are past the age of retirement. Hence, 65 years of age is used as a standard benchmark to identify if you are able to borrow for longer periods.
Should I take up a mortgage loan with shorter tenure or longer tenure?
A mortgage loan with longer tenure will incur more loan interest through the loan tenure. However, the principal is repaid to the bank at a lower rate over the longer tenure which reduces the monthly instalment, making it more affordable and allowing for better cash flow planning.
Ultimately, it depends on your financial planning and monthly cash flow.
- Longer mortgage tenure will result in you paying more interest to the bank but the monthly instalment is lower and more affordable
- Shorter mortgage tenure will have you pay higher monthly instalment but is less expensive as the incurred interest is significantly less in the long run.
At present, the longest tenure you can take on a mortgage is up to 35 years without considering your age at the time of borrowing.
4. What is a monthly instalment?
The monthly instalment is the amount you need to pay back to the bank for the loan taken. The amount is typically a mixed calculation of loan interest and principal to be repaid.
The monthly instalment stated in loan offers serves as guidance on the amount repaid to the bank every month. However, the exact figure may change if the Overnight Policy Rate changes.
In the first 5-8 years of repayment, the monthly instalment is typically weighted towards clearing off loan interest rather than principal borrowed. Hence, if you are looking to offset your loan interest, the best time to do advance payments (for flexi-loans) is in the first 5-8 years.
5. What is an early settlement?
An early settlement happens when the borrower resolves the full loan payment before the loan’s tenure period. In most mortgage loans, there is a lock-in period to discourage borrowers from settling their loans early as banks earn less profit from the lower loan interest charged.
In most flexi-loans, an early settlement after the lock-in period should not have any penalty. However, if you took a basic term loan, any early settlement before the loan tenure will likely be penalized as per the loan agreement signed.
Fun fact: If you are looking to refinance your property, refinancing will be considered as an early settlement and any penalties associated with an early settlement will be applied.
6. What is a lock-in period?
A lock-in period is the time frame where you are not allowed to fully resolve your mortgage loan. This is typically the first 5 years from the first drawdown on your loan. The typical penalty for early settlement within the lock-in period is 3-5% of the loan amount or in accordance with the loan agreement.
The best way to work around the lock-in period is to use a flexi-loan and do advance payments without settling the loan. This can be done by putting in advance payment of up to 49% of your loan amount in the first 3 years and up to 89% in the 4th – 5th year.
At these percentages, it does not trigger the lock-in period’s penalty while reducing the borrowed principal, reducing the loan interest charged.
While this is a rather generic recommendation, it is best to seek advice from your mortgage banker and understand the detailed terms and conditions stipulated in your loan agreement.
7. What is a progressive payment?
A progressive payment is commonly applied for mortgages taken against new developments. As the development progresses, an incremental amount is released by the bank to the developer in accordance with agreed milestones. The released amount is charged on interest and is paid monthly until the building is completed.
Developers are allowed to make claims from the bank once the development reaches the milestones agreed in Schedule G/ Schedule H of the Housing Development Regulations 1989.
Whenever a claim is made, the bank will release the agreed sum to the developer. Once such payment is made, you the borrower will be required to start making monthly payments. Different from the monthly instalment we discussed earlier, these monthly payments are minimal and it consist only of the loan interest.
In other words, during the construction period of your new home, minimal payments will need to be made to the bank as the development progresses. These minimal payments consist only of loan interest and will not contribute towards clearing off the principal borrowed.
8. What is loan disbursement?
A loan is considered fully disbursed when the loan amount is debited into the designated account on behalf of the borrower. For mortgage loans, the loan is disbursed when the bank pays the agreed amount into the account of the seller or property developer.
For homebuyers looking into new developments, there is also a common term known as the “first drawdown”.
The first drawdown on a mortgage loan activates the loans’ terms and conditions and is important to understand the lock-in period. Upon the first payment from the bank to the developer, the lock-in period will be triggered and the period’s start is from the date of the first drawdown.
9. What is margin of finance?
The margin of finance is the amount of loan borrowed expressed as a percentage of the property’s agreed valuation. The higher the margin of finance, the higher the leverage is on the property. This also means less equity in the property for the borrower.
The margin of finance is also commonly known as a loan-to-value ratio (LTV).
In Malaysia, the highest margin of finance one can expect to get on their loan is up to 90% if the borrower has less than 2 mortgage loans at the time of borrowing. If you are looking to take up a 3rd mortgage loan under your name, the highest margin of finance you can expect is 70%.
My personal quick recommendation for couples looking to buy a home together is to not borrow under a joint name. Meaning to say, you can choose to have both names on the Sales and Purchase Agreement (SPA) but if you can afford it, have only 1 name on the mortgage loan under a third party loan.
As a couple, you have a total combined allocation for 4 mortgage loans with a 90% margin of financing, 2 allocations under the husband’s name and another 2 allocations under the wife’s name.
If you register both names under 1 mortgage loan, the financial system will consider both individuals as utilizing 1 allocation each under their names. Effectively, you will be utilizing 2 allocations in a single mortgage loan.
10. What is a third party loan?
A third party loan happens when the property is purchased under more than one name but is only registered under one name in the mortgage loan. Third party loans are unique to banks and are typically allowed between family members and spouses.
In third party loans, only the name of the individual registered under the mortgage loan will be reflected in CCRIS report.
Final Words
Thank you so much for reading this article. I hope the information shared through my writing has been helpful in your journey in building your investment portfolio.
Until the next article, take care and stay safe.
