Purchasing a home is a costly affair. In fact, it can probably be one of the biggest financial decisions of your life. The idea of owning a comfortable place to occupy is bliss to many, yet when preparing to dive into the chaotic financial side, many are left lost and confused. This three-part article will help introduce to you on mortgage terminologies, basics of conventional home loans, and how best to choose the plan suited for you and some basics of Islamic home loans.
A simple home loan scenario :
The bank evaluates and determines the type of loans eligible for the individual. As banks use different methods to calculate your worthiness, it depends on the bank itself and how they recognise the individual.
The bank evaluation of the individual is called credit score review, which determines your eligibility (with respect to salary, debt servicing ratio, risk profile, property and etc).
After the approval, the bank lends a certain amount of money to the borrower to purchase the desired assets. The individual will then use the borrowed money to pay a certain amount of the house value after they pay the initial amount needed to onset the home.
When buying a home, the bank loan will only cover a certain amount of the house value. This is called margin of finance. Usually for first-time home buyers, they are able to get up to 90% loan of the total house value. The total amount the bank loans is termed principal amount. The remainder sum of 10% is called a down payment. A down payment is usually paid using the individual’s own savings. The duration of which the individual has to repay the bank is termed tenure.
For example, Ah Kaw has borrowed RM450,000 from HSBC Bank to finance his mortgage of RM500,000. His annual interest is 4.35% over the next 20 years, therefore his monthly payment estimation is RM2810.62. Make sense now?
On a side note, lock-in period refers to the length of time where you’ll incur an exit penalty if you choose to fully pay off the loan at hand. For example, if you borrowed RM50,000 with a lock-in period of 3 years, you will pay a penalty of 3-5% for wanting to opt out early by paying the loan in full.
The agreement between the individual and the bank is to repay the money, compounded with interest structured by the bank.
Banks in Malaysia uses the Base Rate (BR) system, which determines their interest rates based on their own efficiency. This is different from the previous system called Base Lending Rate (BLR), which the interest rates are predetermined by Bank Negara. As such, customers are unable to borrow below the value of the base rate.
For example, Public Bank has BR of 3.52%. However, the amount the individual must focus on would be the Effective Lending Rate (ELR), which has the connotation of ‘+x%’. So if Public Bank has a BR of 3.52% and an interest of ‘1.1%’, the total ELR would be 4.35% per annum.
For more information on base rates and effective lending rates, read this article from iMoney. Also, calculating all these data and numbers can be quite confusing. Banks use the reducing balance method for mortgage loans. This method is preferred due to the interest calculated being charged only on the outstanding amount of the loan. The interest compounded is minimal as compared to the simple flat interest rate.
All these terminologies are rather confusing at first, especially when doing your own research in regards to home loans. However, all these information are important as it will affect the types of conventional loans that will be explained in Part 2 of this article. The more you know, the better your financial judgement becomes!
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