Guide to Mortgages

Mortgages: The Basics of Buying a Home in the UAE

If you’re new to buying a home, this article is the place to start. We’ll go over what mortgages are, how they work, and what to expect when you take out a mortgage on a home.

So what is a mortgage? Simply put, it’s a loan you use for purchasing a home. These loans are long-term, often taking twenty years or more to pay off. They are also secured loans, or in other words, the bank uses your home as collateral should you be unable to make your monthly payments.

The Two Types of Mortgage Payments: Interest Only and Repayment

When you take out a mortgage, you’ll have two options:

  • Interest-Only Mortgages are mortgages that ONLY pay off the interest on the loan, and not the actual debt itself. For example, a 750,000 AED mortgage over the course of 25 years will still be 750,000 AED. To pay this mortgage off, investments are set up (such as a pension, an ISA, or an endowment) for the strict purpose of paying for the home in full in time.
  • Repayment Mortgages are mortgages that charge an individual both a set per-month cost on the debt owed plus interest. Once the final mortgage payment is made the house is completely paid off.

(Note that some lenders will offer a mixture of these types of mortgages)

Not all mortgages are created equal                

There are many different types of mortgages available. This section will go over the most common, and list some of the most important details about each type.

  • Standard Variable Rate (SVR) Mortgages, as the name suggests, uses a non-fixed interest rate. This rate will go up or down depending on the base rate of the bank that the loan is attached to. When interest rates rise, your monthly payment will go up. When interest rates go down, your monthly payments will decrease. Note that delays do exist and it’s never guaranteed the lender will move the rate in perfect conjunction with the bank’s base rate.
  • Fixed Rate Mortgages are the opposite of SVR mortgages in the sense that their interest rates do not fluctuate. You’ll be offered an interest rate at the onset of the mortgage, and whether interest rates in general move up or down, your interest rate on your home will not change. That said, fixed rate mortgages don’t always last the entire length of your mortgage. There may be a 10-year fixed rate, after which the bank reevaluates the interest and offers a renewed interest rate agreement.
  • Discounted Mortgages are sometimes offered by lenders as a way to slightly reduce the % cost of a SVR mortgage. You may receive a discounted mortgage at .05% percent off the SVR for 5 years, after which you pay the full standard variable rate.
  • Capped Mortgages combine both variable and fixed mortgage concepts. You’re given a maximum limit that your interest rate can rise, but otherwise it will rise and fall as a normal SVR mortgage would. In most cases, capped mortgages have a pretty high ceiling in terms of how high these interest rates can go.
  • Tracker Mortgages are entirely tied to the base rate of the bank you loan from. It operates as a SVR mortgage in every respect but that. Some include a minimum interest rate level, and other lenders will only offer this for a set period of time. However, it isn’t unheard of to have this type of mortgage available throughout the entire length of your home’s mortgage.
  • Current Account Mortgages merge your mortgage with your current account to create a single balance. Other lenders take this concept even further, connecting credit cards, personal accounts, and all additional personal loans into one lump account.
  • Offset Mortgages are like current account mortgages in that they rely on your savings to reduce what’s owed on your mortgage. Unlike current account mortgages however, your bank accounts (both saving and current) are kept separate.

How much can I afford to pay?

Not long ago, banks would allow just about anyone to take out a home loan. That all changed after 2008, and since then lenders have become much more cautious about who they loan to. While they may stop some people from buying their dream home, it can also save people from purchasing a house they can’t afford.

It’s critical that you know how much you can afford per month on a home. This isn’t just the cost of the home itself—it’s the interest rate as well.

You can speak to your lender about this. He or she will go over their offerings, and they have their own calculations that they use to determine whether or not you can afford the monthly payment. This is often based on your salary and living expenditures per month (i.e., your affordability assessment), as well as:

  • Additional earnings from commission, bonuses, second jobs etc.
  • Financial support (trusts, child support)
  • Investment income

One thing your bank is sure to do is stress test your ability to pay off the mortgage. This is done by calculating ALL of your costs for the month, and then raising these costs to account for things like inflation, higher interest rates, and “unforeseeable” costs such as the cost of having a new child, or if you needed to purchase a new car. They may even look to see how long you could make payments if you or your spouse lost a job, or became ill.

Speaking with the bank isn’t the only option of course. Another option is to discuss possible mortgage payments with a certified mortgage expert. A mortgage expert will look at your income and determine the loan-to-income ratio, which is basically what you can afford to pay per month. If, for instance, you had an income of around 500,000 AED, a loan-to-income calculation would identify a borrowing amount of perhaps three or four times as much, which could allow for a mortgage of 2,000,000 AED or more.

You can also try out the UAE Money Expert’s Budget Planner and Calculator.

Beginning the loan process

Before you go to see the lender, make sure you have everything prepared. That means proof of employment, salary, a list of expenditures, bank statements, business accounts, etc.

Another tip recommended by UAE Money Expert is to have an emergency fund on the off chance that you cannot make a payment during a particular month. Please see the emergency fund page for more details. You should have this saved before you apply for the loan—not after.

Lastly, you’ll need to consider how much you’re willing to deposit up front. The biggest factor in driving down the cost of your mortgage is this down payment. The more money you put down, the less risk the bank has to take on. This is the most effective way of getting a lower interest rate.

These days, first-time home buyers put down around 20% of the home’s total cost as a down payment. This will land you a decent interest rate—nothing special, but a good deal nonetheless. For very competitive mortgage rates, you’re likely to see a down payment of about 35% and even 40% of the home’s total cost.

This isn’t possible for everyone. The good news is first time buyers can and do have options, even below the aforementioned 20% mark. These options include shared ownership and assistance from family and friends.

 

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