Part 3: What to know when applying for a home loan

Before our first-time buyer Bontle made the offer to purchase she had built up a deposit of R72 000 and obtained a pre-approved home loan from her bank at an interest rate of 8.2%. However, after signing the offer to purchase she decided to shop around to see if she could get a better mortgage offer. Capitec was able to offer her a rate of 7.7%.

According to Wiehahn Kock, Head of Business Solutions at Capitec, there are several factors that affect the interest rate when approving a home loan application as interest rates reflect the risk premium the banks place on the mortgage.

• Home or investment property? A primary property – in other words your home – will usually have a lower interest rate than an investment property. Banks know that people are most likely to prioritise their home repayments and therefore it carries a lower risk.
• How big is the deposit? The size of your deposit will determine the loan versus the value of the property. The lower the mortgage relative to the value of the property, the lower the risk to the bank. Kock says a deposit of 20% or more would be considered as a low loan-to-value home loan. This will have a very positive impact on the interest rate charged to the client. If the deposit is less than 20% this would be classified as a high loan-to-value mortgage, however, the fact that there is a deposit would still have a positive impact, which is why Bontle qualified for a lower rate. Kock says a deposit also improves your affordability as your repayments will be lower.
• What is the credit score and employment status? The next step is to look at the individual. A client with a higher score is considered a better credit risk and a lower interest rate would apply. Having a history of a stable employment would also improve your risk profile and therefore your interest rate. Self-employed people may be considered a higher risk, however, Kock says if one can prove consistency in earnings then this could lower the interest rate charged.

Once the interest rate and therefore monthly repayment has been determined, the bank then assesses the affordability of the customer to meet those repayments.

By asking for a pre-approval you will have a sense of whether your current finances are sufficient to qualify. If you are turned down, or the interest rate charged is well above prime, it could make sense to delay buying a home and focusing on improving your credit score and affordability.

Credit score – and how to improve it

If you have legal action against you or a poor credit score due to non-payment of loans, the bank may decline your application. However, in most cases where an application is approved, your credit score still matters as it impacts the interest rate that you would be charged.

It usually takes around six months for your credit score to reflect an improvement if you take these steps:

• You can improve your credit score by ensuring the payments on all your loans are up to date.

• If you have multiple unsecured loans such as store cards, making these paid up and closing them could also have a positive impact on your credit score.

• If you are looking to create a credit history, you can take out a credit card but set the limit really low like R2 000 a month and make sure you pay in full at the end of the month.

• Financial commitments like payments to policies and insurance premiums all count towards your credit score.

Affordability – and how to improve it

Kock says that one of the main reasons for turning down home loan applications is due affordability – even if the customer’s credit score was acceptable. You must be able to afford the repayments for the mortgage to be issued.

There are several ways to improve your affordability:

• Pay off short-term debt. This will free up cashflow to put towards your mortgage repayments. If you are over-committed on car finance, it may make sense to focus on paying off the car as quickly as possible and then applying for home finance.

• Build up a deposit. While banks do offer 100% mortgages, in some cases a bank may require a deposit. Even if you qualified for 100% mortgage, if you can put down a deposit, the amount you need to borrow, and therefore repay is reduced. It also shows the bank that you have the ability and discipline to save.

• Include additional income. Kock says the bank will consider additional streams of income such as a side business in terms of affordability. So even if you are earning a few thousand rand from some after-hours work, make sure you include it in your application.

• Your rent counts. Most applicants are currently paying rent. Koch says the bank will take into account that the rent would be freed up to pay towards the mortgage. Having paid rent timeously each month will also reflect on your bank statement and improve your credit risk.

Keep in mind that even if a bank approves a mortgage, you need to check that you can really afford it. There are many additional costs to being a homeowner that you will incur once you move in. Although Bontle qualified for a mortgage of R1.6m million, she chose to purchase a property at a lower cost and only committed to a mortgage of R1.3 million.

FAQs

Should I fix my interest rate?

With interest rates currently so low, is now the time to fix your home loan rate? While Capitec only offers variable bonds that are linked to the prime interest rate, some banks offer a fixed interest rate. The problem is that fixed rates are always higher than the current rate, in the same way that a bank offers a higher interest on longer-term fixed deposits. Banks will also only offer fixed rates over one to three years. If you selected a fixed rate for three years you could pay up to 2% points higher than your current rate. Rather than fixing at a higher rate, increase your repayments. You know you will be able to absorb any future rate hikes and that extra payment goes straight to paying off your capital rather than servicing a higher interest rate.

Is now a good time to buy with rates so low?

The lower interest rates have made buying a home more affordable. However, you do need to keep in mind that we are at the bottom of the interest rate cycle. Once the economy starts to recover and inflation creeps up, we can expect to see rate increases in the future. No-one is certain when this will happen, but it will most likely happen in the next two years. Keep this in mind when assessing your affordability. How much would future rates need to increase to affect your ability to repay the mortgage? The upside is that hopefully in two years’ time you would have had a salary increase and be better able to afford any increases.

What is the difference between a home loan and a mortgage?

The terms are used interchangeably, but there is a technical difference. The home loan is the credit facility that the bank grants, while the mortgage bond refers to the legal agreement that is in place – but for practical purposes it is the same thing.

By Maya Fisher-French

*This is part 3 of a 6-part series in partnership with City Press, which takes a first-time home buyer through the process from beginning to end.