What is the difference between fixed and variable interest rates, profiting, and other concepts related to mortgage?

First Time Buyer Guide

Are you lost with all the terms related to mortgage and you find difficulties to find the right meaning of the mortgage terms?

"Fixed term", "Variable rate", "Repayment", "Tenure", "LTV", "DBR" etc. Want to buy a house, but confused and put off by the jargon? Well, we hope this guide helps fill in the gaps.

Equated Monthly Instalment (EMI)

Refers to the monthly payments that you make towards repayment of the loan amount, over the term of the loan. The EMI = payment towards mortgage principal + payment of interest

Buyout/Re-Mortgage

Transferring your mortgage from one lender to another.

Early Repayment Charges (ERC)

As the name suggests, ERC refer to fees that lenders may charge you if you decide to pay off the mortgage earlier than the initial term of the loan . These charges are now regulated by the UAE Central Bank and buyers can expect to pay 0-2% of the outstanding loan amount depending on when they close their loan. The fee is 2% during the fixed rate period, and 1% during the variable rate period, and free after the 7th year of the mortgage.

Equity

When you start paying off your mortgage, you start to build equity in the property. For example, if you've bought a property worth AED 1.5mn and have already paid off AED 500,000 that means you have built up AED 1,000,000 worth of equity in your property. This allows you to take either a top-up loan/equity release, which is additional borrowing on your existing loan that can be used for a variety of purposes.

Equity Release/Top-up/Additional Borrowing/Further Advance

After a mortgage has been fully disbursed, you can apply for additional borrowing at any time, subject to eligibility. You can use the built-up equity in your home to take out a loan to consolidate loans, or pay off unexpected expenses.

Loan-to-Value (LTV)

Loan-to-value refers to the percentage of the property value that the lender is willing to lend you. This is governed by the UAE Central Banks regulations, with specific details below.

Term/Tenure

This is the length of time over which you agree to pay off your mortgage. Mortgage terms/tenures are regulated by the UAE Central Bank, with a minimum period of 3 years and a maximum period of 25 years.

Mortgage Rates Types

Fixed Rate Mortgages

Charge a set rate of interest that does not change throughout the life of the loan. Although the amount of principal and interest paid each month varies from payment to payment, the total monthly payment remains the same.

Fixed rate mortgages are a great option for those who prefer:

• Fixed payments - Your monthly payments will stay constant throughout the term of the fixed interest rate.
• Unaffected by changes in general interest rates – You are protected from sharp increases in interest rates, but also can't take advantage of lower rates, unless you refinance.

Variable Rate mortgages

The interest rates can be changed at regular intervals (typically annually) by the lender or on the Account Review Date. This means that your monthly payments would usually change from year to year, and may decrease or increase.

Why it might be suitable for you:

• Variable payments – Your monthly mortgage payments may change from year to year. Therefore, to avoid any unexpected surprises, you should invest time in understanding how the rate is trending.
• Possibility of lower payments – However, since rates are variable, you may be offered a lower starting interest rate.
• Rate calculation – Variable rates are generally linked to a standard rate, which may be a Central Bank rate, or an internal base rate set by the financial institution. If you want to be an informed borrower, it's wise to know what your variable interest rate is based on.

Repayment Method

There are many different types of mortgage loans available, each offering different features and benefits. There are also various ways in which mortgage loans can be repaid. The type of mortgage loan that will suit you best depends entirely on your circumstances both now and in the future.

Repayment Mortgage Loans

With a Repayment loan, your monthly instalments are made up of two elements:

• The interest you pay on the loan
• The repayment of the capital sum.

The exact proportion of capital repaid in relation to interest paid is dependent on the term of the loan. A shorter term generally means that you will start to pay more capital than interest at an earlier stage.

A Repayment loan is the only option that will guarantee to repay your loan over a defined term, provided that you keep up with your payments.

Interest-Only Mortgage Loans

With an Interest-Only loan, your monthly payments cover the interest and no capital is repaid. As you are repaying only the interest, your monthly payments are lower than a similar value Repayment loan. However, you will need to find a way to repay the capital at the end of your Interest-Only period. An Interest-Only payment method can be selected for both under construction property phases as well as completed property phases. Please note, however, that under UAE Central Bank Regulations, Interest-Only loans can only be made available when buying the property for investment purpose with a loan period no longer than 5 years from the first drawdown date.

Insurance

Most mortgage lenders require you to have insurance. It can come in various types, and we hope the following clears up any questions.

Loan Protection Insurance/Life Insurance

For most lenders, it is mandatory to have Loan Protection Insurance (LPI) during the term of the loan, to cover the total amount borrowed. The insurance may cover a number of risks including sickness, disability or death. The premium is typically charged monthly and is usually added to the monthly instalment of the mortgage. Cost of the insurance depends on a number of factors, which can include age, health, lifestyle, smoking habits, or length of coverage. Most lenders will offer this insurance as part of their group policy. Alternatively, if you want to use your own insurance policy, many lenders will allow you to assign it , although there may be a fee for doing so. In addition, under certain circumstances, clients may be allowed to Opt-Out of insurance.

Property/Buildings Insurance

This insurance policy protects the owner in the event of certain types of damage to the property. Property insurance typically covers fire, wind, hail, theft and more. Property insurance is charged yearly and most lenders will offer this policy. Property insurance is mandatory on villas and townhouses. The recent building fires in Dubai Marina, Musaffah and Saadiyat Island have shown that property damage is a very real risk. As a result, all buyers are encouraged to check the insurance arrangements on any tower blocks where they are buying.

Contents Insurance

This provides coverage that pays for damage to, or loss of, an individual's personal possessions whilst they are located within that individual's home. Contents insurance is generally not mandatory, but is offered by most lenders . Contents Insurance is especially beneficial for valuable items such as jewellery and artwork, which have unique value and are difficult to replace.

Paying interest on a loan of money is forbidden under Shariah law, so many lenders offer Islamic mortgages that comply with Shariah law, as well as 'conventional' mortgages.

What is a conventional mortgage?

With a conventional mortgage, a financial institution such as a bank will lend money to purchase a new home and they will charge interest on this loan.

A conventional mortgage is made up of the principal (the amount borrowed) and also the interest charged on the loan. With most mortgages, the principal and interest are paid off monthly over 25 years, which is why they are also known as repayment mortgages.

In the early years, most of a borrower's payments are set against paying off the interest with a smaller part reducing the principal. As the end of the term nears, this switches so that more is paid off from the original loan each month.

What is an Islamic mortgage?

An Islamic home loan works differently because Islamic financial institutions are forbidden from charging interest. There are several Islamic financing models, Murabah and Ijarah being two key models used for home loans.

Murabaha financing

With Murabaha financing, the bank purchases a property on behalf of the customer and 're-sells' it to them at a profit. The buyer then pays the bank back through monthly instalments.

Islamic banks need collateral to protect against the buyer not making their repayments, so the property is registered to the bank until all mortgage payments are complete, although there are some banks that will include the tenant's name on the title deed.

An advantage of a Shariah-compliant home loan is that there are no additional interest payments for late payments (though the bank may charge a fixed fee).

Ijarah financing

Another Islamic financing model applied is Ijarah, which a buy and lease-back arrangement. This model is useful if you are buying a property off plan as no payments are made until the property is completed.

As an example, here's a simple calculation with an Islamic mortgage using Ijarah

Let's assume that you are purchasing a property worth AED 1,000,000 and you make a down payment of 200,000 with a loan of 800,000 to be repaid over 4 equal annual instalments. You would currently own 20% and thereafter, your repayment schedule would look like this:

So essentially, over the years you are buying a larger portion of ownership of the house, similar to the principle on a conventional mortgage. As a 'co-owner' of the house the bank charges you 'rent'. However, as you buy out the bank's share of ownership the rent liability decreases over time. Assume that the rent is 200,000 per annum, you would pay as follows:

Taking out a mortgage is one of the biggest financial decisions you'll make, so it's important to review your mortgage costs regularly and take action to reduce them where you can. You could save hundreds of thousands of Dirhams over the term of your mortgage.

What is a remortgage?

Remortgaging is when you replace an existing mortgage with a new one, either with your current lender or with a new one who will ‘buy out' your existing debt.

When should you remortgage?

If you're on a fixed rate mortgage and still within your fixed period, we advise reviewing your mortgage shortly before your fixed period is due to end. About two months gives you time to look at options. If you're on a variable rate mortgage, reviewing your mortgage once a year should ensure you remain on a good deal.

How do you know if remortgaging is worth it?

To determine whether it's worth remortgaging, you need to work out whether you can recoup the costs of remortgaging, and start to save money, within a reasonable period of time. If you're moving onto a fixed rate mortgage, you should be looking to recoup costs well within the fixed rate period. This is because you'll revert onto a higher rate once your fixed period ends and may need to remortgage again.

There are three key factors that determine whether or not it's worth remortgaging:

• the headline interest rate of your existing and new mortgage
• the costs of remortgaging
• any exit penalties you may need to pay.

A good mortgage advisor, will be able to run a cost analysis for you and advise on whether it makes financial sense for you to remortgage.

Step 1. Compare interest rates

If you're on a variable rate mortgage, or on a reversion rate, it's likely you'll be able to find a better deal.

It's always worth going to the bank, or lender, you have your mortgage with and asking them what they'll offer to keep you as their customer. You can then use this to compare against other mortgages in the market.

Step 2. Work out your remortgaging costs

Remortgaging is not cost free. You'll need to pay several fees associated with taking out a new mortgage, so make sure you factor these in when you assess whether it's worth remortgaging:

Step 3. Know what your exit penalties are

It's likely that your bank will charge you a penalty for exiting your mortgage early. If you remortgage, your new bank will take on these costs by adding them to your mortgage (so you'll need to consider the penalties plus the interest).

In 2019, the UAE Central Bank decreed that lenders can charge up to 1% or 10,000 dirhams, whichever is the lower amount, to clients who exit their mortgage early.

Remortgaging isn't a hassle and many can save tens, or hundreds, or even thousands of dirhams

While remortgaging can feel like a hassle, the savings are well worth it. So, once you take out a mortgage, make sure you keep reviewing it regularly.

Asking independent mortgage advisor is the easiest way to remortgage. They'll analyse your potential costs and savings and find the best products in the market for you. Don't delay – you could be losing a lot of money instead get in touch with our PSI Mortgage Advisor to take the hassle away from you and help you make big savings on your mortgage.