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Mortgages and their returns

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HOME ownership is a goal most of us have.  Unlike buying a mobile phone, television or even a car, the cost of a home is usually a multiple of the buyer's annual salary and normally requires long-term financing to achieve the purchase and ultimate ownership.

Smaller asset purchases such as furniture are easily financed by credit cards, which can be repaid in months.  Cars and motorbikes can be financed by short-term loans, usually with terms of three years.

However, purchases of homes can be in the hundreds of thousands of dollars, and sometimes millions, and may take anywhere from five to 30 years to repay.  For most people who wish to borrow to finance the purchase of a home, a mortgage is the form of loan for what may very well be the largest asset purchase they make in their lifetime.

A mortgage is the transfer of an interest in property to a lender as security for a debt, usually a loan of money.  In the case of residential property mortgages, the home and land are used as collateral on the loan. The transfer of interest from the owner to the mortgage lender is on the condition that the interest will be returned to the owner of the property when the terms of mortgage are fulfilled.

The debt is generally secured with the title of the property, and the mortgage allows the borrower to spread the acquisition of the property over a period of years.

If the borrower is unable to repay the mortgage loan, the lender can usually foreclose on the mortgaged property and, subject to legal requirements, the property may be sold with proceeds applied to the original debt.   

Pick and choose

There are different types of mortgages with varying options available. The parties to a mortgage are the mortgagee, or mortgage lender, which is usually a bank, and mortgager, who is the borrower that owes the obligation secured by the mortgage.  

A MORTGAGE IS THE FORM OF LOAN FOR WHAT MAY BE THE LARGEST ASSET PURCHASE MADE IN A LIFETIME.

Most buyers of property may either not have sufficient savings or may not wish to invest a large portion of their wealth in a single asset.  As a result the buyer may wish to borrow a portion of the property acquisition cost.  A down-payment, the borrower's partial payment for the property acquisition, is required by the lender and the loan principal is the amount actually borrowed to purchase the property.   

The maximum amount of the loan is usually based on a "loan-to-value ratio (LVR)" which expresses the amount of the loan as a percentage of the value of the property. For example, if a borrower wants $50,000 to purchase a house worth $100,000, the LVR is $50,000 divided by $100,000, or 50 percent.  Banks in Cambodia generally have LVR limits of 50 percent.   

Interest is the amount the bank charges the borrower for use of the money. Given that the loan is usually of such high value, the amount of time to repay, or the term of the loan, can be as long as 30 years. However, in Cambodia repayment is usually required within 10 years, although some banks offer terms up to 15 years.

The cost of the mortgage is comprised of principal, interest and other fees, such as loan approval fees or loan administration fees.  The total is divided into equal payments over the life of the loan using a process called amortization.  

The term of the mortgage has a material impact on the amount of interest paid and the overall return on the property investment.  The shorter the term of the loan, the less interest paid and the higher the return.  

For instance, if the mortgage is $100,000 at an interest rate of 10 percent, the total interest cost for a seven-year mortgage will be $39,450; for a 10-year mortgage it will be $58,581 and for a 15-year mortgage the interest cost will be $93,430.

Interest options

Both fixed-rate and variable-rate mortgages are available in Cambodia. A fixed-rate mortgage charges a set rate that does not change throughout the life of the loan.  A variable-rate is based on a base rate plus a margin. The base rate can be adjusted, higher or lower, based upon market conditions.  

With a fixed-rate mortgage, the borrower can predict and plan more easily and is protected from increases in payments if market rates rise.  

Variable-rate mortgages generally have lower initial rates than fixed-rate mortgages, and borrowers can benefit from declining market interest rates.  However, if market interest rates rise, borrowers will be required to pay higher rates.

Fixed-rate mortgage rates in Cambodia ragnge from approximately 10 percent to 15 percent, while variable-rate mortgages are around 10 to 11 percent.

Infant market

The mortgage market is still in its early stages in Cambodia, and there is still a low penetration rate among property buyers.

But with a growing middle class, increased home ownership and bank borrowing gaining greater acceptance, the use of mortgages to finance home purchases is likely to increase.

Educating the public on the advantages and disadvantages of mortgages will greatly contribute to Cambodia's ability to avoid the mistakes the world's financial markets are presently confronted with due to widespread mortage misuse.  

__________________________________________
Anthony Galliano is head of corporate and

institutional banking, ANZ Royal Cambodia.

Should you wish to contact Anthony,

please send an email to gallianoa@anz.com

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