Should You Take a Loan to Finance a Property?
This article will focus on buying a house in Nigeria through a mortgage system prominently known as a housing loan. For the purpose of clarity, a mortgage is a debt instrument, secured by the collateral of specified real estate property that the borrower is obliged to pay back with a predetermined set of payments. This way, mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front.
Over a period of many years, the borrower repays the loan, plus interest, until they eventually own the property.
Before considering a mortgage as the way to acquire a home, you need to first ask yourself the following questions;
- Do I want to own a house of my own?
- Do I want to buy a house of build it?
- What kind of property do I have in mind?
- Do I need to take out a mortgage?
- Can I truly afford to buy a house?
- Is this the right time for me to buy a house?
- What are the pros and cons of taking out a mortgage?
Once you have answered these questions, you need to take into consideration the following factors before approaching your bank for a mortgage loan.
- Are you mentally prepared for a mortgage?
Funding any project is no doubt important. It can be very trying for a lot of people, causing them sleepless nights as they think of how to balance all the bills and yet finance the project at hand. Raising funds to buy a property is no different. One has the option of coming up with the money himself/herself or, better yet, securing a loan. Loans need to be repaid over a period of time and this scares people. But a loan might be just what you need to leap to the next level.
- Can you pay back?
You must be brutally honest when answering this question because you will be required to provide proof you can afford it, in order to secure the loan. Problems will inevitably arise if you can’t repay your debt. It will suffice to project, if you run a business, how much you could make after the loan has been secured and put to use. This should be based on concrete, empirical evidence if I may add. For the employed, how much do you earn? Can you pay in instalments over a period of time and still live comfortably?
- Read the terms very carefully
The lending institution most likely has a legal document containing terms of the loan. Read this carefully and make certain to fully understand the terms before securing a loan. Is the interest rate exorbitant? Or can you get something better elsewhere? If you have trouble grasping the contents of the fine print, get legal assistance from a lawyer.
- What if the worst happens?
This seems rather pessimistic, but you have to consider all possibilities. If you can’t repay the debt and you lose something else you had listed as collateral, can you recover? If you can’t, and you are a hundred percent sure you can’t, it might be wiser to leave out the loan. To protect your sanity, that is.
- Mortgage brokers are not banks
You must understand very clearly that the mortgage industry is unregulated. Mortgage brokers are not banks and do not play by the same rules. There have been several cases of ‘bait and switch,’ where people were promised ‘A’ but ended up with ‘X.’ An important point to note here is that you do not have to accept any last minute changes.
- The moment you are not comfortable with any changes, politely walk away.
Allow us to put this into proper perspective. Below are 12 warning signs hinting you walk away from the loan. You should be wary if the loan representative encourages you to:
- Borrow more than you need.
- Overstate your income or understate your outstanding loans or expenses.
- Agree to payments that you can’t afford.
- Sign blank forms.
- Equally bad signs are if they:
- Fails to give you mandated disclosure documents
- Pressure you in any way
- Are unresponsive to your calls, is disorganized, repeatedly asks for the same documents, or is constantly blaming others for delays
- Tries to sell you credit insurance or extra products you don’t want
- Tries to make you do something that is against your better judgment.
- Requires that you give the deed to your property to anyone.
- Change any of the terms of the loan at closing.
- Be warned that the deeper into the process you get, the more the momentum builds and the tougher it is to back out. Dishonest lenders know this and always certainly count on it.
- Do not organize a mortgage over the internet
While it might be perfectly okay to search for an apartment in Surulere online, do not take out a mortgage over the internet. The reason for this is simple. There are too many variables during the process and the last place you want to get caught in the mix of such variables is the internet.
However, this does not mean that you should completely strike out the use of the internet when searching for rates. You should, in fact, go online when searching for rates because there are reliable websites that can help you get good rates, figure out your potential loan as well as provide other relevant information. What we are saying here, in essence, is that you should not rely on firms that solely conduct business on the internet.
- Mortgages are risky
Suppose you apply for a loan to buy a house worth N10 million with a 20% down payment.
What this means is that you owe the bank N8 million minus interest and other fees. If the market takes a hit and the value of the home reduces by 30%, a big problem arises as the home is now worth N7 million but you still owe the lender N8 million.
The bad news is: If you need quick cash and need to sell the home, you will lose a pretty sum.
The good news is: This is not a common occurrence as the property market in the country is pretty stable. However, there is a possibility this might happen, so you should be prepared for this.
- Mortgages are profitable
Apart from helping buyers purchase homes that they hitherto could not afford, mortgages have some other gains that they offer the buyer. Real estate properties are not as volatile as stocks, thus, they have a fairly stable value.
Properties provide a hedge against inflation as they are not easily affected by inflation, unlike stocks. You can borrow against your equity whenever you need cash. Suppose you have paid back N5 million out of your N8 million loan, your equity in that home becomes N5 million and you can borrow money using this equity as collateral.
Real estate experts suggest that property values could appreciate up to 7.5% annually in prime locations. You would agree that this is worth more than stocks are yielding these days.
- Get ready for extra fees
There will be some fees you might be required to pay before and after your mortgage loan is approved and these include insurance and appraisal fees. You will also be required to pay an annual interest, which might be as high as 18%. If you are buying a house in an estate, you might be required to pay an infrastructural development fee and this might cost as much as a million or two.
- Interest-only loans are to be avoided
You should generally avoid interest-only loans except you have plans to move in a short period of time or if the loan is one you consider a short-term bridge or a construction loan. For those who might not know, an interest-only loan is a loan in which, for a set term, the borrower pays only the interest on the principal balance, with the principal balance unchanged. Taking an interest-only loan and paying only interest does not build any ownership or equity in your home.
- How reasonable are the fees?
It is very important to find out precisely what the loan you are taking will cost you.
Are the fees reasonable? You should find out if the fees are reasonable. It is clearly understandable that you cannot avoid some specific fees but you should know that quite a number of fees are unnecessary and are known as ‘junk fees.’ In the worst case scenario, they are negotiable. You should ensure you get a good faith estimate statement that clearly spells out your total expected fees.
Some companies include all the fees in the interest rate they quote you. Below are some of the fees you should ask questions about:
- Application fee
- Title search
- Credit evaluation
- Underwriting (They are arbitrary)
- Escrow fee
- Prepayment Penalty (The fee paid if you pay off your loan early)
- Loan processing fee (They are arbitrary)
- Appraisal fee (This is the cost to estimate the value of your home)
- Points (If you pay points, ensure that your interest rate is reduced. Generally, avoid paying any points if you plan to live in your home in less than ten years)
- Title Insurance (You have to pay to protect the lender. However, ensure the Title Insurance specifically protects you as well)
- Documentation (Also arbitrary)
- Interestingly, the fees highlighted below are almost always ‘junk fees’:
- Amortization schedule fee
- Trustee fee
- Financing statement fee
- Appraisal review fee
- Credit report review fee
- Document preparation fee
- Inspection fee
- Photo inspection fee
- Underwriting fee
- Warehousing fee
- Administrative fee
- Computer fee
- Courier fee
- Notary fee
When you ask about your interest rate, also remember to ask about the APY (or Annual Percentage Rate). This is usually higher and a more accurate reflection of your true interest rate.
- Avoid losing your home
If you make just the minimum loan payment, you could find yourself owing more than your home is truly worth in a space of two years or even less. Rather, you should always strive to pay at least, the full interest payment. Also, you would be better off making regular a payment, which would include both principal and interest.
- Stay away from adjustable rate loans
It is always wiser to avoid adjustable rate loans. In truth, they come across as being attractive because the advertised rate is lower than a fixed rate.
However, they generally allow you four payment options:
- Minimum payment (Do not make only a minimum payment. It will not cover the interest on your loan and can quickly lead to a situation where your home is worth less than your loan)
- Interest-only payment (This is also not advised because no money is going to pay down the loan or create home equity)
- A fully amortized 15-year loan (Similar to traditional loans but interest rate is adjustable)
- A fully amortized 30-year loan (Also similar to traditional loans but with adjustable interest rate)
Here are three reasons you could consider an adjustable rate:
- If you are absolutely sure that the interest rates cannot rise from current level
- If the loan ceiling on the adjustable rate is below the current fixed rates
- If you plan to sell your home prior to the first rate adjustment
- questions to ask about your potential ARM rate
Adjustable rate loans are known to begin with a ‘teaser rate.’ This is an artificially low rate, which will get adjusted higher at the first adjustment opportunity.
If you do consider an adjustable rate, be sure to ask:
- What is the rate based upon (often a current T-bill or LIBOR rate plus an additional amount)? Get complete details
- What would be the rate today if you already had the loan and it adjusted to current levels?
- What is the floor? (This is to find out how low can the rate go from this point)
- What is the ceiling? (This is to find out the highest rate you would have to pay)
- How frequently can the rate be adjusted?
It is crucial that you fully comprehend each of these parameters and get them in writing.
Note: In a situation where you cannot afford the loan ceiling and the fully amortized payment at that level, do not accept the loan.
Shoot to avoid paying mortgage insurance
As a general rule, if you can avoid paying for mortgage insurance; do not hesitate to do so. In truth, some loans require mortgage insurance while others will waive the insurance if you have a low enough debt-to-home equity ratio when you take out your loan. Most mortgage insurance ends up protecting the lender and not you.
When you take out a mortgage, always make it a priority to deliver your full payment each month. Also, strive to pay on time and pay more towards principal whenever you can.
Would you consider taking a mortgage in Nigeria?