What you need to know about mortgage rates

An article written by Jason Julien, CFA -
which appeared in the Business Express, a
Trinidad Express Newspapers publication.

The basic components of a mortgage loan tend to be:

i. Property: the physical residence being financed.

ii. Mortgage: the security interest of the lender in the property, which may entail restrictions on the use or disposal of the property. Restrictions may include requirements to purchase home insurance and mortgage insurance, or pay off outstanding debt before selling the property.

iii. Borrower: the person borrowing who either has or is creating an ownership interest in the property.

iv. Lender: any lender, but usually a bank or other financial institution.

v. Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.

vi. Interest: a financial charge for use of the lender's money.

vii. Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.

The lender tries to take into account the relative riskiness of the mortgage loan, that is, the credit worthiness of the borrower and the likelihood that the funds may not be repaid. This perceived risk is quantified and is reflected in the cost or interest rate of the mortgage facility.

There are generally two basic types of amortised mortgage loans: i) fixed rate mortgage and ii) adjustable-rate mortgage (also known as a floating rate or variable rate mortgage). Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.

In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life of the loan. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan.

In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index.

All new and existing residential real estate mortgages will fall under the scope of the new Guideline by the Central Bank. The Guideline contains two key features: i) the requirement that a "disclosure statement" be provided to customers and ii) the introduction of a Mortgage Market Reference Rate (MMRR). The Disclosure Statement essentially summarises the pertinent facts of the mortgage contract in an easy to read and understandable format.

The MMRR is an interest rate benchmark against which mortgages are to be priced and re-priced and will be announced by the Central Bank on a quarterly basis. The MMRR is computed by the Central Bank based on information on the commercial banking system funding costs and yields on applicable treasury bonds. The actual interest rate on your mortgage will be derived from the MMRR plus the margin charged by the lender. The lender's margin will be based on the credit worthiness of the borrower and the Lender's profit margin.

If the MMRR declines, borrowers will benefit from lower mortgage rates once you have an adjustable rate mortgage that is due to be re-priced. Of course if the MMRR rises, your mortgage rate could rise but the lender has the option not to increase the rate. Also, the Guideline states that over any three-year period, the interest rate on your mortgage will not increase by more than 3.5 per cent or the increase in the Central Bank's "repo" rate, whichever is larger.

The MMRR will be announced on a quarterly basis. Since it was effected in December last year the MMRR has declined from 3.50 per cent to 3.25 per cent. Remember this is not the interest rate on your mortgage but the base reference rate on which your mortgage interest rate will be determined. As the MMRR trends downward so too will your mortgage interest rate; thus Borrowers can expect to see lower mortgage interest rates at present.

So as market interest rates continue to be subdued and trend downward so too will the cost of mortgage loans. This of course is good news for new home owners and if current borrowers. However, the interest cost for existing borrowers will change dependent on the terms of their mortgage contract with the Lender; this may mean that the interest rate will not be adjusted frequently but only on the anniversary date of the mortgage facility.

This Guideline is certainly good news as it offers greater transparency for borrowers so as the terms come into effect this month for existing mortgages let us each reach out to our lenders to better understand how the new Guideline and MMRR will benefit us as customers.

Live richly, you can follow me on Twitter at: @julienomics

Jason Julien is a Financial Analyst and Registered Trader and can be contacted at: ask.living.rich@gmail.com or followed on Twitter at: @julienomics



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