As EIBOR rates continue to gallop
northwards, is it time to consider early settlement or partial settlement of
the outstanding mortgage loan?
Over the last decade, the
property market in Dubai has provided its residents a very interesting
investment opportunity. Property has been one of the most interesting investments
in recent years and many residents have profited from it. While many of the
larger investors have taken the cash route, a large percentage of current
investors have taken the mortgage route to ownership. Hence as we come to the
end of the low interest rate regime and we anticipate a sharp increase over the
next few year, it is important to review the possible scenarios that mortgage
holders face at this time.
Before we get into the possible scenarios and options facing
the investors, let us first look at the interest rates over the last few years
and quarters. A key benchmark in the country remains EIBOR or the Emirates
Inter Bank Offered Rate and many of the mortgage loans are linked to this key
reference rate. The EIBOR itself is a daily reference rate published by UAE
Central Bank based on the average interest rates at which UAE banks offer to
lend to other banks in UAE. So how has the EIBOR changed over the last few
periods? For the sake of comparison, we have looked at EIBOR over the last 3
years from the period January 2015 to Mar 2018.
You will note that relatively slow rate of change since 2015
until the last quarter of 2017. Since the last quarter of 2017 you will also
note the sharp increase in the rate moving from 1.56% to 2.30% within a period
of 6 months. This trend is expected to continue as US Fed Reserve continues to
suck out money and trim down its balance sheet with at least 2 more rate hikes
expected this year.
Looking forward into the future, what could be the possible options
available to the mortgage holder in UAE? Every individual’s situation and
circumstances are very unique and hence the final decision needs to be
carefully thought through based on your own risks and opportunities. This blog does not in any way make any
recommendations but only presents a few possible options available.
The first and foremost consideration for any individual
needs to be setting aside emergency funds. Have you set aside the required
funds aside for the possible extreme emergency like situation? It would be
important to set aside at least funds to cover your day to day living for a
period of 6 months. This includes your rent, car loan, utilities, school fees,
grocery bills etc. Only once you have set aside emergency funds should you
consider any scenario related to prepayment of your mortgage.
Most experts would advise you to never prepay your mortgage
given that it is possibly the cheapest loan you have in your portfolio. This
holds completely true so long as the excess funds can be deployed into more
profitable investments. If possible avenues for investment and expected returns
exceed the cost of loans, it would be prudent to deploy the funds into other
investments like equity or equity related funds. As an example, if the cost of
your loan is 4% and potential returns from investments is say 5%, it would be
good to continue with your investment plans subject to cost of your loan
remaining the same over a reasonable period. If the return on other investments
and cost of your loan (after assuming any increase in costs of loan over the
near future) are the same or if the return on investment is lower than the cost
of finance, it would be worthwhile to prepay your outstanding loans. Based on
the fact that we seem to be at the latter part of a business expansion cycle,
it would be worthwhile to factor potential investment risks in the future.
If you have excess funds available and do not see
interesting investment opportunities in the near future, you may consider using
part of the funds to prepay an outstanding loan. Remember excess funds refers
to all funds after the emergency fund has been set aside. Once needs to calculate
all costs and benefits based on your own unique situation. However I have made
assumptions to illustrate the situation below.
Assumptions:
- Current Outstanding loan: AED 700,000
- Cost of finance: 4.75% with a potential increase to up to 5.25% over next 12 months
- Remaining tenure of loan: 7 years
- Hence the EMI is approx. AED 9,812/-
Based on the above, the total payout amounts to AED 824,184/-.
This includes a payment of finance cost of AED 124,184/-.
Assuming that you have AED 200,000/- unutilized ‘excess’ funds
in your account and assuming that you have ticked off all potential investment
opportunities, what is the potential impact in case you consider repaying part
of the outstanding loan amount? If you decide to make a prepayment of AED
200,000/- and the EMI remains the same, there is a potential saving in finance
cost of approximately AED 64,740/- as compared to the current cost of AED
124,184/-. For details refer to the table below.
Total savings on making a prepayment of AED 200,000 amount
to AED 64,670/- while also reducing the tenure from 84 months to around 57
months.
As mentioned previously, each individual’s situation is
unique and any decision related to prepayment needs to be taken by you based on
your unique situation. In my case, I see merits in making a prepayment as I
have unutilized funds in my bank which can better utilized by making a partial
payment of my outstanding mortgage?
How does this compare to your situation? What are your
thoughts on this strategy? Leave your comments below.
This post is in no way intended to be advice to any individual. Each reader needs to analyse his or her unique situation and take the most appropriate decision that suits him or her.
