What is a mortgage loan?
The term mortgage loan refers specifically to loans that financial institutions make to individuals to finance the purchase or improvement of a home.
Typically, mortgage loans cover a sizable share of the value of the property (70% or more) depending on the bank’s financing policies, and have repayment periods that span up to 20 years or more (different banks apply different terms).The borrower repays the loan over the repayment period, with an interest rate appropriate to compensate the lender for the expenses it incurs in making the loan and the risk that the institution takes on, while also providing a reasonable return to the lender.
What is the purpose?
A mortgage loan can be used to purchase a house, make home improvements, or purchase furniture. Typically, a mortgage loan is secured by a lien on the property that is being financed, which gives the lender recourse to the property in the event that the borrower does not fulfil his or her obligations.
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Main phases / steps involved in getting a mortgage loan
1. Pre-application stage
The Mortgage Loan officer assists the applicant with the mortgage loans terms and conditions, explaining the direct and indirect costs of a mortgage loan. If the customer agrees with the terms and conditions, the loan officer proceeds to provide the applicant with a list of documents necessary to support the application and perform a first screening of the potential borrower. Also the loan officer prepares the tentative loan repayment schedule to the applicant.
2. Application stage
The applicant completes the loan application form and provides the supporting documents as required by the loan officer (by signing the application the customer grants permission to contact his or her current and past employer to verify the information, as well as to contact other agencies that may have information on him or her).
3. Verification of documents
The loan officer after receiving all necessary documents verifies the borrower’s income and employment history, the assets and liabilities, the borrower’s credit history, completes a legal review of the collateral documents and requests an official appraisal of the property to be used as collateral. These steps complete the qualification analysis after which the loan officer prepares the recommendation for Loan Credit Committee.
4. Review of the file
The file prepared by the loan officer is reviewed by the bank’s Loan Credit Committee, which checks the recommendations of the loan officer/underwriter and determines whether to approve the loan, and at what conditions.
5. Notification of the decision
After the Loan Credit Committee reaches it decision on approving or rejecting the loan, the officer contacts the applicant to inform him or her of the decision. If the loan has been approved, the loan officer informs the applicant on the loan conditions and on any additional documents needed.
6. Open of the new account
If the applicant does not already have an account at the bank, he or she is set up with a new account to be used for the loan repayment.
7. Final document for disbursement
The mortgage agreement is deposited at the Registry Office of Immovable Properties so that the property can be registered in the bank’s favor. The borrower submits to the bank the life and property insurance documentation. Once all the additional documents are in place the bank is ready to disburse the funds to the property’s seller or to the borrower’s account in case of reconstruction or furniture purchase.
8. Final documents after disbursement
After the disbursement of the funds, the borrower is provided with his/her own original copies of the contracts (Loan and Mortgage Agreement), original copy of the Life and Property Insurance, copy of the costs statement and the detailed loan amortization schedule.
The foremost elements of Mortgage Loan
The interest rate on a mortgage is generally set to be either:
- Fixed over the life of the loan
- Variable, changing periodically with changes in market interest rates (this is the most common applied);
- Or some combination of the two; for example a fixed interest rate for a number of years, then varying (lately applied by several banks).
Over the life of a variable-rate loan changes in the interest rate may be determined by one or more factors such as:
- A published index of inflation
- An index of market interest rates
- Changes in the rate the lender pays on deposits
- The discretion of the lender
As a general principle, a lender should vary the interest rate that it charges on its mortgages frequently enough to track changes in the interest rate that the institution will pay for the funds that it uses to finance the loans, always maintaining a satisfactory positive spread between the two rates. The indexing scheme should also create an understandable and reasonably predictable payment structure for the borrower.
Where a reliable index of inflation or interest rates exists, a lender may choose to tie both the interest rate that it charges on its mortgages and the rate that it pays on deposits to changes in the index, assuring a positive interest spread for the institution, and transparency for the mortgage borrower.
Amortization schedule refers to how the outstanding balance on a mortgage loan changes over its life. Under most mortgages the outstanding balance is consistently reduced over the loan’s life to ensure that the unpaid balance on the loan will never exceed the estimated initial value of the property that serves as the primary collateral. Fixed-interest-rate mortgages are generally self-amortizing such that the principal declines consistently and the loan is fully paid off by the end of its term. Mortgage payments, which are typically made monthly, contain a capital (repayment of the principal) and an interest element. The amount of capital included in each payment varies throughout the term of the mortgage. In the early years the repayments are largely interest and a small part capital. Towards the end of the mortgage the payments are mostly capital and a smaller portion interest. In this way the payment amount determined at outset is calculated to ensure the loan is repaid at a specified date in the future. This gives borrowers assurance that by maintaining repayment the loan will be cleared at a specified date, if the interest rate does not change.
Once the funds have been disbursed one of the most important documents issued by the bank is the loan amortization schedule which clearly outlines the payment dates of the monthly instalments. For the mortgage loans amortized with fixed monthly payments (capital plus interest), the loan payment starts thirty days after the disbursement date (according to the mortgage product type). The instalments are paid on fixed date of each month (taking in consideration also the holidays).
The customer should pay the monthly instalment in due date as already specified in the schedule in order to avoid penalties and fees. Banks strictly follow mortgage re-payments and in case of delays take immediate action to contact the borrower.
Mortgage loans in emerging markets are generally denominated in either
- The local currency in the country; or
- One or more reserve currencies of developed markets, such as the US dollar or Euro.
As a general principle, lending institutions should match the currency in which they offer mortgages to the currency of the funding source they are using to finance the loans. In markets in which the value of the local currency is unstable or where inflation is running at very high rates, lenders face significant challenges in offering loans denominated in the local currency.
The most important and necessary documents that a customer needs to provide to a bank to be consider for a mortgage loan
The document or documents certifying the borrowers and co-borrowers incomes are amongst the most important and crucial documents in the mortgage approval/rejection analysis.
A borrower’s personal income may come from a variety of sources; salary from full time employment, salary from part time employment, income from rental properties or other investments etc. There are banks that will include remittances from abroad in their calculation of personal income.
The certification of employment and salary issued by the employer should be of a recent date, should clearly state the employee’s position, the duration of this position in the company, the net monthly salary, and also whether social insurance contributions are being regularly paid or not. The certificate should be duly signed by the employer, stamped with the company seal, and to bear the employer address and phone numbers.
When a loan application is filed with the bank the loan applicant gives the bank the right to verify that all the information provided is truthful, including the income information.
In case the borrower receives income from a private activity, the applicant should submit all the necessary documents (such as financial statements for the last three years), and the bank is allowed to make the due diligence (including site visits to investigate the financial figures, contact the suppliers etc).
The primary source of the loan repayment is expected to be the cash flow from the borrower’s income, the secondary source is the sale of the house or the pledged collateral. The reason for the collateral is to provide assurance that there is an alternate source of payment. If things go awry, the bank will receive its funds back through the liquidation of the collateral .Since the value of the property is an important factor in establishing the risk of the loan, determining the value is a key factor in mortgage lending. It is important for the bank in case of repossession of collateral to receive a high selling price in order to cover all the expenses of execution as well as the remaining loan balance, thus the role of the appraisal is also very important on the process. The appraisal of the property in almost all the banks is performed by private appraisers, selected by the bank based on their training and professional experience.
The bank’s decision on financing the loan or not is always based on the value given by the appraisal. Usually banks strive to have a loan that does not exceed 70 % of the collateral’s value however there are banks which do accept higher percentages such 100%.
The customer’s credit history is also a key factor in the loan approval process. Even if the prospective borrower is not a current customer of the bank the payment history is one of the points carefully analyzed by the bank. Before approving any loan, all banks in Albania request information held in the Credit Register on the borrower, or company seeking to borrow money. The Credit Register is an electronic database kept by the “Bank of Albania and it holds all available information on loans made in Albania. The main purpose of the Credit Register System is the storage and administration of information on the borrowings of each borrower in the banking system in the Republic of Albania. This information is used for credit risk evaluation when a new loan is requested by any customer. Not having a positive credit history increases the chance of loan requests not being approved therefore having a good credit history (always paying your bills on the due dates) becomes very important in determining whether a loan is approved or not.
- A filled out mortgage application (signed by the applicant(s));
- Photocopy of the passport of the applicant and of the applicant’s spouse;
- Verification letter issued from employer;
- Borrower’s recent photo;
- Family Certificate issued within the last 30 days;
- Copy of the rental agreement is currently living in a rented property;
- Copy of the employment contract;
- Employer’s verification of the applicant’s current salary;
- Photocopy of the activity license (in case of private activity);
- Financial statements for the last three years (in case of private activity);
- Selling or Preliminary Contract/list of works /furniture
- Title certificate issued by the Immovable Property Registration Office.
- Building’s evaluation by a licensed appraiser (recommended by the bank).
An important part of the mortgage loan procedure is the preparation of the Loan and Mortgage Agreement which is a written agreement between the borrower and lender that lays out the terms under which the institution is advancing funds, the conditions that must be met before funds are disbursed, and the borrower’s obligation to repay the loan. The contract, will also serve to secure the lender’s interest in the property and acknowledge that the lender has a claim against the property if the borrower fails to live up to his/her obligations.
At the outset, a mortgage contract will typically specify:
- Who the parties are to the agreement, including the full name or names of the borrowers and any co-borrowers (collectively, the “Mortgagors”), and the legal name and corporate identity of the lending institution (the “Mortgagee”). Where co-borrowers are involved, the contract will specify the degree to which the obligations and liabilities undertaken are joint and several that is, applying to each borrower individually and to all borrowers collectively.
- The property that is serving as collateral for the loan. This will typically include the property address, as well as a reference to the plot of land on which the residence is built, including its legal registration in public land and/or tax records.
- The contract should specify the amount of funds that the Mortgagee is lending to the Mortgagor, including the currency in which the funds are to be paid. The contract will also lay out the terms under which the Mortgagor is obligated to repay the funds, including:
- The number of payments that must be made, typically expressed as the number of months during which the mortgage is in force;
- The interest rate that the Mortgagor will pay on the funds that are advanced by the Mortgagee;
- How, if at all, the interest rate will change during the course of the loan;
- The initial interest rate and initial payment amount;
- The schedule on which payments are due (typically the first day of each month), as well as the acceptable form(s) of payment and where payments are to be made;
- How any excess payments will be allocated by the Mortgagee (typically first to paying any due or past-due interest, then to the unpaid principal amount); and
- Whether any penalty will apply and, if so, the size of such penalty should the Mortgagor fully repay the loan before its term is complete.
The contract should list the covenants or promises by which the Mortgagor agrees to be bound during the course of the mortgage. The contract should also state whether the breach of any covenant will constitute a default under the mortgage.
The most important and necessary documents that a bank will need to provide to a customer
Usually the loan application is a standard format that each bank applies and it contains information on:
- The purpose of the loan
- Loan duration and down payment
- Information regarding the property which is going to be financed
- Extensive personal data about the borrower and co-borrower (educational background etc.). Information concerning the current and prior employment and incomes of the borrowers and co-borrowers.
- List of all other expenses, including other loan installments, if there are any.
Once the funds are disbursed, the bank should provide to the customer an original copy of the Loan and Mortgage agreement, an original copy of the life and property insurance, a copy of the costs statement and a copy of the amortization schedule.
The amortization schedule should be signed by the customer in order to avoid any discrepancy on the loan repayment. The amortization schedule should contain the following data:
- Specifications on the customer such as name and other information;
- The account number to be used for the repayment of the loan;
- The interest rate (specifying the base rate and the spread);
- The monthly installment date;
- The principal amount before the loan installment and the amortization schedule.
As the amortization is schedule is issued only once per year in case of the adjusted rate, the Customer should be careful to be provided the next year the new table as per the new interest rate.
Banks do not apply fees when the application is first received. Similarly, if the loan request is rejected, no fee is applicable. In case the loan request is approved, the customer has to pay initial fees such as administrative expenses (paid at the moment the file is established) and the appraisal fee for the evaluation of the property. Once the disbursement procedure begins, the customer must pay the rest of the expenses related to the loan (see the article on mortgage costs).
Main issues /topics need to know about the evaluation of property
The appraisal is the estimation of the price at which the property might reasonably be expected to be sold or let if it is offered for sale/lease. The Real Estate appraisal in general uses techniques which are carefully defined, but productive only when used by experienced practitioners. There are several methods that can be used to asses the value of a property, amongst which “the cost”, market and income approaches.
The appraisal information is very important to the bank’s decision on approving or rejecting the loan .No mortgage loan should be made without an appraisal for it provides an evaluation of the value of the loan’s collateral. Based on the value provided by the appraisal, and on other information, the bank decides on the loan amount to be financed.
The evaluation report of a real estate property when prepared to be used by a bank requires an interior and exterior inspection of the subject property.
Other elements included in the evaluation are:
Subject: Basic information such as the address, legal description, owner’s and/or borrower’s names. The client is also identified here.
Contract: Information on the contract for sale is entered here for appraisals in which a change of ownership is about to occur.
Site: Data on the size, shape, zoning and access to utilities, clear, descriptive photographs of the subject property and comparable sales used.
Improvements: Physical characteristics of the property such as age, materials, and condition Street map that shows the location of the subject property and of all comparable properties that the appraiser used.
The appraisal is performed by a licensed specialist. In Albania licensing is based on a Decision of the Council of Ministers dated 1996, as well as the appropriate regulations prepared by the Ministry of Public Works, Transport and Telecommunications. In addition, Albanian appraisers have set up their own association called “The Albanian Real Estate Appraisals” in order to encourage standards development and the exchange of ideas.
The appraiser is hired to protect the bank’s interests and is not to be influenced by the applicant’s opinion on the value of the property.
The cost of the property appraisal is paid by the would-be borrower. There are banks which ask for the payment of the appraiser prior to the loan’s approval, while other banks pay the appraisal fee by subtracting it directly from the loan amount disbursed to the customer .Usually the fees vary depending on the agreement between the bank and the private appraiser. (See Costs involved in a Mortgage Loan).
What are costs involved in a Mortgage Loan
The costs of a mortgage loan vary from bank to bank. As such when you are choosing the right bank for you one of the issue you have to keep an eye on are these costs.
- Administrative expenses (cost),
which vary from bank to bank (It can vary from 1% to 1.5% of the loan amount, Min EUR 150). For example: if you have a mortgage loan of 50,000 Eur, it would mean that you might have to pay an administrative fee of EUR 500. The administrative expenses can be paid upfront in the moment of the loan approval or can be paid during the loan disbursement (this varies from bank to bank)
- Notary expenses
for the notarization of the documents, endorsement, pledge agreements. The costs vary from bank to bank, depending on the number of contracts and the agreements of the bank with the private notaries, Min. Lek 5,000.
- Life insurance costs:
Prior to being approved for a mortgage loan, it is mandatory for the applicant to have in place a life insurance policy. The cost of the Life Insurance Police varies based on the loan amount and the borrower’s age, meaning the higher the loan value or the older the borrower the higher the premium to be paid. Usually the premium of a life insurance police is paid annually, based on the outstanding loan amount and typically the bank chooses the insurance company. Insurance companies do not issue life insurance police for customers older than to 60-65 years.
- Property insurance premium:
Typically the bank requires that the collateral be insured from earthquakes and fires. The insurance premium might be paid annually or once for all period of the loan and it depends on the value of the loan amount and/or on the value of the property (Some banks request that the entire value of the property be insured, instead of insuring just the value equal to the outstanding loan balance so the premium in this case would be higher than the one insuring only the loan value).
- The appraisal fee:
The cost of the evaluation depends on the collateral to be evaluated (apartment, shop, land, villa etc) and varies from bank to bank as per the agreements between banks and the appraiser.
- The expenses for the registration of the property
- Expenses for the maintenance of the bank account.
It varies from bank to bank (from 150 Lek , 1.5 USD /EUR -500 Lek , 5 USD/EUR)
- The lender may charge a prepayment fee
In the event that a borrower prepays his/her mortgage before the full term of the loan, the lender may charge a prepayment fee, generally set equal to a modest percent of the unpaid principal balance (varies from fixed penalties up to 5% of the unpaid loan amount). The decision by a lender as to whether to charge a prepayment fee is tied, in part, to the nature of the mortgage whether its interest rate is fixed for any period of time or varies over the life of the loan, and to the source of funds that are used to finance the loan. Where a lender fixes the mortgage interest rate it charges for any extended period of time and finances that loan over that period with a matched-duration fixed-rate debt instrument, an early payoff of the mortgage could leave the institution with a long-term asset (the mortgage) extinguished, while a long-term liability (the funding instrument) remains on its books. In this case, the institution may choose to charge the borrower a prepayment fee, to compensate for the loss of the flow of income.
The basic, main terminologies /words used in the mortgage industry
The following terms are ones you should know and understand before you decide to buy a house and apply for a mortgage loan in the financing institutions:
What is the importance of the Life and Property Insurance? Why are they mandatory?
Life insurance is a form of transferring risk from the customer to the insurance company. Insurance reduces the financial exposure and facilitates the life of family members in the case of a tragic event (death). Insurance policies have an important social impact as they decrease the individual costs and public ones in case of tragedies.
If the borrower dies of becomes permanently disabled, the insurance company pays off to the bank the outstanding loan amount, and the bank relinquishes its claims on the property. In this way, family members are protected by further bank obligations.
Similarly as with life insurance, it is in the bank’s interest to ensure that the borrower regularly pays the monthly premiums for the property insurance. In this way the bank’s collateral is protected from disasters such as earthquakes or fires.
Life and property insurance policies are mandatory requirements by the bank.
The customer is free to take out additional insurance against potential damages such as that caused by fire, water, broken windows, or bodily injuries to the borrower which can affect his or her ability to repay the loan.
What can I do as a customer if I can not make the monthly payment?
Lenders are actually equipped to handle the temporary financial setbacks that their customers sometimes experience and have devised repayment plans designed to help you regain control of any late mortgage payments..
Most of the plans that mortgage lenders use to help you get back on track involve either rolling the late payments to the end of the loan, breaking the payments up over the next few months and paying a certain amount toward the past due balance in addition to your regular monthly payment, or completely restructuring the loan. If your financial troubles are more than temporary, you may want to discuss placing your house on the market or opting for a short sale in order to close the bank obligations.
Whichever route you choose, the main thing to bear in mind is to contact your bank (loan officer) as soon as you realize that making your payments has become a problem. By keeping in touch with your lender, you are creating a line of trust that can only help you in the long run.
this article is extracted by Albanian Association of Bank (www.aab.al) and it is prepared by IFC
© 2009 International Finance Corporation
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