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1.0 Introduction

Nowadays, economic in Malaysia seems to be recovering from the recession since 2008 because

of significantly affected by the U.S country as they are the dominator in economic activities.

Malaysia is one of the countries affected, thus it may also reduce the purchasing power of

population. Instead, lower purchasing power may make worst to people who desire to own a home

in this moment.

Prior to Asian financial crisis, Malaysia encountered economic expansion and caused the

increased in houses price and interest rates and forced into inflation. This is supported by the data

collected which is the inflation index from 51.2 in 1980 up to 91.0 in 1997 stated by Bank Negara

Malaysia (BNM). Thus, many mortgage borrowers are unable to repay the mortgage and drove

them into foreclosure. Instead, investing in a house still is a good choice but not everyone can

afford the amount of home prices. Nevertheless, many people do not have the purchasing power

towards a home so they are decided to rent a house.

After tired of paying for house rental for a plenty of time and economic recovering period,

people will think of buying a house. According to BNM, the data and statistics (in Appendix A)

illustrated that GDP is currently increasing from $193,092 billion in 2010 to $273,803 billion in

2011. Besides, owning a home would be one of the necessities for a family in life. However, people

who desired to own a house are required to obtain a source of financing which may supplied by

banks and other similar financial institutions except they are able to pay for the home amount

without financing.

Many people found that borrowing mortgage is just as easy as imagined but actually it

does not. This is because of instead of borrowing, borrowers are required to analyze in terms of

mortgage packages, managing their mortgage financing during the lifetime until at the end of the

period where the total amount are offset by their payments. All these processes need knowledge

and experience, especially for first time buyer.

2.0 Objectives

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The aim of this research is to determine whether borrowers made the right mortgage

decision when they plan to purchase a house.

Specifically, this research is to examine how the advantages and disadvantages of types

of mortgage will affect borrowers' decision. Next, is to investigate an ideal mortgage borrowers

should own. Last, is to identify the factors that enclosed with the best mortgage.

3.0 What is mortgage?

A mortgage loan is loan secured by real property through the use of a mortgage.

According to Sirmans (1998), the term mortgage is refers to the both instrument that pledges real

estate as security of obligation and the process of pledging the real estate as security. In addition,

a home buyer can obtain a loan either to purchase or secure against the property from a financial

institution, such as a bank. This is supported by statement of home buyer pledges house or as

collateral to the bank, thus the bank has a claim on the house if the home buyer default on paying

the mortgage (Investopedia, 2012).

To finance a mortgage, we need to take into consideration some factors for example

income, debt and stability. This is because mortgage financing amount always influenced generally

by the income factor which higher income level can thus proved the borrowers are acquired good

creditworthiness to repay for the amount. Besides that, we consider the debt, which is the amount

that we owe or accumulated after borrowed the mortgage. This is to define how much we can

afford if we plan to buy a home. Next, we take into account the stability factor which comprises

employment history, environment factor and economic. For example, we will only plan to buy a

home or borrow mortgage when economic expansion or high employment rate and vice versa.

Mortgages are categorized into two, prime and subprime. Prime mortgage is a high quality

mortgage and is eligible for purchases or securitization in secondary mortgage market. Prime

mortgage loans have low default risk and made to borrowers with good credit records.

Subprime mortgage illustrated the mortgages which are not classified as prime mortgages

are also known as subprime loans. According to Mayer and Pence (2009), subprime mortgage

defined as securitized if the originator does not hold it in portfolio. It is a mortgage that charges less

interest than the market rate for a limited period of time. Many people thought that borrowed more

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than they could afford because they were convinced they would be earning more money and would

be able to afford the higher payments when the preferential interest rate ended.

Subprime loans are high cost loans which designed for people with less than “prime” credit

(Sam, 2008). According to BBC news, subprime lending is providing loans and mortgages for

people with poor credit histories. However, once the borrower unable to repay the payment with the

interest in time, the financial institution will suffer in huge losses. In order to compensate for the

high risk of subprime loans, the financial institution charged higher interest rates on subprime

mortgages.

In 2004 to 2006, many lenders were more flexible in granting these loans as a result of

lower interest rates and high capital liquidity. Lenders entail additional profits through these higher

risk loans, and they will offer lower rate to customers in order to compensate for the additional risk

they assumed. Consequently, once the rate of subprime mortgage foreclosures raise suddenly and

sharply, many lenders experienced extreme financial difficulties, and even bankruptcy.

Besides, there are differences between prime and subprime mortgage. In addition to

having higher interest rates than prime rate loans, subprime loans often come with higher fees. In

contrast, prime mortgage interest rates are quite similar from lender to lender but subprime loans

interest rates vary greatly. A process known as risk-based pricing is used to calculate mortgage

rates and terms which the worse your credit, the more expensive the loan.

Subprime loans are usually used to finance mortgages. They often include prepayment

penalties that do not allow borrowers to pay off the loan early, making it difficult and expensive

to refinance or retire the loan prior to the end of its term. Some of these loans also come

with balloon maturities, which require a large final payment. Still others come with artificially low

introductory rates that ratchet upward substantially, increasing the monthly payment by as much as

50%.

4.0 Products of mortgage

According to Edward J. Kirk, there are two most common types of mortgages which are

fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). Interest rate of FRMs is fixed

throughout the life of the loan while the adjustable rate mortgage (ARM), which initially charges for

a fixed interest rate, and then converts to a floating rate based on an the market value or BLR.

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4.1 Fixed-rate mortgage (FRM)

Fixed rate packages in Malaysia are only offered up to a 3-10 year period, so the types of 20-30

year fixed rate packages offered in many countries are not available. This type of mortgage is

based on the bank’s rate around the time the mortgage is set up and the rate is fixed for the first

few years of the loan term.

In a fixed-rate mortgage, the interest rate, and hence periodic payment, remains fixed for

the life of the loan. Therefore payment is fixed, although additional costs such as others legal

expenses can change.

For a fixed-rate mortgage, payments for principal and interest will not change over the life

of the loan which means the rate will remain unaffected during the entire life of mortgage which

typically 3 to 10 years.

A fixed-rate mortgage is well defined and easy to understand method of financing a home.

Buyers who want to know their assured payments will be during the life of the loan should seriously

consider using this type of financing. Fixed rate mortgage also suitable got people who plan to stay

in the home for a long period of time.

4.2 Adjustable-rate mortgages (ARMs)

ARMs also known as adjustable mortgage loans (AMLs) or variable rate mortgages (VRMs).

In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after

which it will periodically adjust up or down relative to the market value. Adjustable rates relocate

part of the interest rate risk from the lender to the borrower. Furthermore, ARMs are most usual

applied by customers because fixed rate funding is difficult to obtain and is more costly. Since the

risk is transferred to the borrowers, the initial interest rate may be from 0.5% to 2% lower than the

average fixed rate, for example, Public Bank Berhad is currently offer an interest rate of 4.4%

(BLR-6.6% minus bank offer rate-2.2%).

ARMs are somewhat misleading to subprime borrowers in that the borrowers initially pay a

lower interest rate. When their mortgages reset to the higher, variable rate, mortgage payments

increase significantly. This is one of the factors that lead to the sharp increase in the number of

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subprime mortgage foreclosures in August of 2006, and the subprime mortgage meltdown that

ensued.

Moreover, variable rate mortgage is favored by higher risk limit customers. Besides, ARMs

borrowers always hope that the bank rate will remain stable. Adjustable rate mortgages can help to

avoid additional interest charged by paying extra monthly installments over the life of the mortgage,

but the monthly payments will fluctuate up and down in relation to market index.

Other than that, adjustable interest rate depends on the changes of base lending rate

(BLR) which depending on the bank you choose the mortgage from. For example, majority of local

bank refer to the BLR of 6.6% which determined throughout the market value.

4.3 Fixed rate and adjustable rate mortgage, which one preferable?

This question will come up mostly when people looking to buy a home. When they look at the

bank’s posted rates, they usually see interest rates for many different terms for fixed and

adjustable interest rate. For new borrowers, they always choose for fixed rate mortgage even

though they have other options. This because the fixed rate mortgage package is very simple and

easy to understand.

Fixed rate mortgage are usually more expensive than adjustable rate mortgage. Due to

inherent interest rate risk, long-term fixed rate loans will tend to be at higher interest rate than

short-term loans.

The fact that a fixed rate mortgage has a higher starting interest rate does not indicate that

this is worse form of borrowing compared to the adjustable rate mortgage. If interest rate rises, the

ARMs will cost higher while the FRMs will remain unchanged. In effect, the lender agreed to take

the interest rate risk on a fixed rate loan. For adjustable mortgage borrowers, majority is pay less

money in the long-term, but apart from them is pay more. The price of potentially saving money

must be balance with the risk of higher costs potential.

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1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1

2009 2010 2011 2012

4.80

5.00

5.20

5.40

5.60

5.80

6.00

6.20

6.40

6.60

6.80

Base Lending Rate

Base Lending Rate

Axis Title

Figure 1A: Base lending rate

Among the various types of mortgage, fixed rate mortgage is the most reliable. It protects

homeowners from fluctuations in interest rates and provides stability in payment. Every single

month for the entire life of the loan, the borrowers will pay the exact same amount to the bank.

Besides, risk-averse homebuyers are more likely to choose this type of mortgage. Instead,

borrowers always decide to lock-in at lower rate so they will pay without taking interest rate

fluctuation risk.

Fixed rate mortgage borrowers also have more emotional security than those using ARM's.

A borrower under an adjustable rate mortgage may have no idea what the payments for the home

will be in future. Some ARM interest increases can be very high until the homeowners are not able

to make the payment and may forced into foreclosure with losing the home and the equity that has

been built up in the home. However, fixed rate mortgage borrowers seldom have to face this

dilemma.

One of the disadvantages to this type of mortgage is that it can be somewhat harder to get

than an adjustable rate mortgage for some buyers who have less than excellent credit. This is not

always the case, but, in general, lenders are more eager to work with good credit borrowers in the

fixed rate arena.

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Another disadvantage to this type of mortgage is that if interest rates in general drop, the

borrower may end up paying more than others are paying who are locked in at the lower rate. The

only real way to adjust this type of mortgage is to refinance, which can be costly to the home

owner.

On the other hand, the advantage of ARMs is that it generally permits borrowers to lower

their initial payments if they are willing to assume the risk of interest rate changes. These rates

could also stay lower if interest rates remain the same or dip even lower because it depends on

bank offer rate. For example, during this prolonged housing crunch, interest rates are gradually

lower. Thus, the borrowers have benefitted by paying less in interest each month.

ARMs have “teaser” periods, which are relatively short initial fixed-rate periods (typically 1

to 3 years). When the ARM bears an interest rate that is substantially below the indicated rate, it

may attract borrowers to view an ARM as more of a bargain than it really represents. A low interest

rate predisposes an ARM to be precluded from increase in average payment.

Against these possible advantages, however, borrowers have to consider the possibility

that their payments could raise substantially and will not go down significantly even if interest rates

drop.

Adjustable rate mortgages may be less expensive, but at the basis of bearing higher risk.

With unexpected increased in interest rate, the monthly payment can be slightly inflated which

borrowers might not capable to cover the extra payment amount with their unchanged income

level. Consequently, this might forced the borrowers into foreclosure of the mortgage.

Additionally, many ARMs have a penalty for paying off the loan early. Every mortgage

borrowers have a deal with their lenders when they sign for the mortgage, which is their lock-in

period. Once borrowers had agreed with the lock-in period, they are not allowed to finish their

payment within the period. However, if they desire to finish the payment earlier, they ought to pay

for the penalty. For example, Public Bank Berhad charges a penalty fees for 2% of the total

mortgage amount.

5.0 Catch your best mortgage selection.

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5.1 Types of mortgage

A flexible home loan/financing is your best options if you want to pay off your home

loan/financing faster and reduce your interest/financing payable. Adjustable rate mortgage is differs

from fixed rate mortgage, floating rate mortgage borrowers can place an excess payment into

monthly installment which the amount financed can be fully offset earlier and thus pay less than

accumulated interest charged. For example, place an extra RM50 in your financing account can

reduce interest charged for RM2.20 (if interest charged is 4.4%) for every month. In contrast,

excess payment is not involved in fixed rate mortgage because the constant monthly payments

had already been set up, thus borrowers will have to pay more interest charged.

Adjustable rate mortgage borrowers can reduce interest/financing payable by depositing

your entire salary in the home financing account. However, in case they need money immediately,

they can withdraw the excess payment (salary – monthly installment = excess payment) anytime

without fees. This would facilitate those borrowers who working in building construction areas and

has possibility to meet emergency or unexpected incident. So, they can access to their excess

payment in the bank.

5.2 Affordability

Instead of type and tenure of mortgage, borrowers have to consider the element against

monthly total costs comprises of house prices, interest rates, Mortgage Reducing Term Assurance

(MRTA), fire insurance, administration fees and others. Each borrower has different income levels,

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debts and expenses. Though, these factors could determine the borrowers’ repayment ability and

the amount they able to borrow.

According to Hashim (2010), the house price movements are influenced by economic

fundamentals which will affects the purchasing power and borrowing capacity. In addition to this,

the interest rate fluctuations will indirectly give effect to the affordability of customers. If inflation

occurs in an economic, the house prices and interest rates will boom up and thus customers are

unable to borrow and borrowers are not able to make repayment.

ARMs may also be attractive to customers who have higher income level expectations in

the future and offer low costs at the beginning of the term. If their income level rises, they will be

able to afford potential increased in interest rates and comprise the ability to repay on monthly

installments.

5.3 Mortgage term

On the other hand, ARMs may be useful if you intend to own the home for short period of

time because you save in the short term and encompasses less risk. If the housing market is

collapsing, borrowers may accommodate risk that they may not able to sell their home and facing

rising interest rate risk.

In addition, borrowers have to decide their tenure in how long they going to take to finish

the mortgage borrowed. Thus, borrowers can choose to take a longer tenure to pay a comfortable

monthly installment repayment so that it will not be burdensome on them. The tenure limitation was

decided by the bank in which the borrowers choose to apply. For example, Public Bank Berhad

offers for a very long period which is 40 years or up to 70 years old of the borrowers. If the

borrowers apply for longer tenure, so he will pay for a smaller monthly payment. On the other hand,

a longer tenure can be shortened with excess payments the borrowers place in their home

financing account.

Some studies have indicated that ARMs are actually less costly in the long run than ARMs,

but the risk of increasing rates is always a big concern.

5.4 Current base lending rate and offer rate by lenders

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Percent per annum

Average rates during the periodBase

Lending Rate

2010 1 5.51

2 5.51

3 5.76

4 5.76

5 6.02

6 6.02

7 6.27

8 6.27

9 6.27

10 6.27

11 6.27

12 6.27

2011 1 6.27

2 6.27

3 6.27

4 6.27

5 6.54

6 6.54

7 6.54

8 6.54

9 6.54

10 6.54

11 6.54

12 6.53

2012 1 6.53

Sources from: Data & Statistics of Bank Negara Malaysia

Without hesitation, borrowers should lock in a mortgage at the best rate when interest

rates are very low. Consequently, you guarantee yourself low fixed rates and protect yourself

against rising future rates.

5.5 Expectations of future interest rate

Borrowers will take actions if they assume the interest rate will be extremely low and

economic is improving in the future time because they can save their money by lock-in to the lower

interest rate mortgage. So, the demand on adjustable rate mortgage will be slightly increased.

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6.0 How do you borrow a mortgage?

Basic steps you should go through in the mortgage loan process.

6.1 Pre-approval

In having pre-approved mortgage, you will be having the amount that you can afford to purchase a

home. And having one is an advantage when looking for home, since sellers give priority to buyers

who have pre-approved mortgage.

A pre-approval is an application for credit and a lender's written commitment (subject to

verification) of how much they'll let you borrow, letting you know how much home you can afford.

This occurs before a loan application is completed. Pre-approval requires more information than a

pre-qualification application, such as the property purchase price and down payment amount.

Getting pre-approved can help show home sellers you are a serious buyer.

6.2 Loan Application

The mortgage loan application form asks for detailed information about you and the property you

wish to buy, and requires documentation about your personal finances. The lender will examine

this information, as well as your credit history.

6.3 Locking in a Rate

Mortgage loan rates may change daily. To ensure that you receive the rate you were quoted, you

may elect to lock in your rate by paying an up-front authorization fee.

6.4 Appraisal

Your property will be appraised to determine its value. The appraiser will visit the house and will

also consider sale prices of comparable houses.

6.5 Down Payment

Typically, lenders prefer that a borrower have 20% of the purchase price for the down payment. If

you make a down payment of less than 20%, you generally have to purchase Private Mortgage

Insurance (PMI) or MRTA. PMI protects the lender if you default on the loan, and is part of your

monthly mortgage loan payment.

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6.6 Loan Review Process

After the appraisal, the loan file is submitted to the lender for your loan to be reviewed.

6.7 Escrow and Title Preparation

A title company will hold the money and documents until all conditions of the mortgage approval

are met. Title work will be prepared, including a title exam to ensure the title to the property is clear.

Other documents such as the mortgage note and deed will be prepared.

6.8 Closing Costs

The costs associated with processing and closing a loan, such as application fees, points, title,

insurance, and credit processing. Your lender should provide you with a "Good Faith Estimate,"

advising you of the estimated costs you may have to pay at loan closing. When budgeting for your

new home purchase, be sure to factor in closing costs.

6.9 Signing

The documents will be sent to a title company for you and the seller to sign. Funds such as any

remaining down payment and closing costs will be due at this time. Closing costs normally include

such items as appraisal fees, title exam, settlement fees, title insurance, credit report fees, and

application fees.

6.10 Title Transfer

When all funds are collected and the contract has been verified, the title is transferred and the

purchase price funds are disbursed to the seller. After this step, you can take over the keys to your

new home.

7.0 Recommendation and Conclusion

This study has reviewed the foreword of mortgage and its instruments offer to the customers.

Subsequently, the research discovered the mortgage loan the borrowers desired and bank offer

when purchasing a home. Mortgage loan also a risky investment which in economic expansion, the

inflation may occur and thus increased the house prices and interest rates. Therefore, customers

who borrow within the period will encounter unanticipated increase in interest rates. This will lead

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to high costs covered by the borrowers and probably forced them into foreclosure the loan. A

similar case was happened in US where subprime mortgage arisen and those borrowers had lost

their home.

As a result, borrowers should consider cautiously and take corrective actions and make

precise decision especially when they are choosing their preferred mortgage package. Borrowers

must always look for the correct timing and choose to lock-in the mortgage when interest rate is

low. So, this can be profitable.

As a conclusion, from this study we can conclude that adjustable rate mortgage is most

popular and applicable for everyone nowadays. It is the most benefits for borrowers in purchasing

a house. Instead of get the right choice of mortgage, factors such as BLR and bank offer rate,

mortgage tenure, affordability, and expectation of future interest rate should be considered.

8.0 References

Amr A.G. Hassanein, M. M.-B. (2008). The Egyptian Mortgage Practice. International Journal of

Managing Projects in Business , 260-278.

BBC News. (n.d.). Retrieved March 14, 2007, from http://news.bbc.co.uk/2/hi/business/5144662.stm

Constantine Lymperopoulos, I. E. (2006). The Importance of Service Quality in Bank Selection for

Mortgage Loans. Managing Service Quality , 365-379.

Hashim, Z. A. (2010). House Price and Affordability in Housing in Malaysia. Akademika , 37-46.

Home Loans. (2012). Retrieved March 07, 2012, from HSBC:

http://www.hsbc.com.my/1/2/personal-banking/home-loans/buying-your-first-home

Kirki, E. J. (n.d). The Subprime Mortgage Crisis. An Overview of the Crisis and Potential Exposure , p. 2.

Leece, D. (1997). Mortgage Design in the 1990s: Theoretical and Empirical Issues. Journal of

Property Finance , 226-245.

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Loans and Financing. (2012). Retrieved March 05, 2012, from Public Bank Berhad:

http://www.pbebank.com/en/en_content/personal/loans/5home.html

Magavern, S. (2008, October 1). Subprime Lending. The Rotten Core of the Current Economic Crisis , p. 1.

Mohd Akasyahwafiuddin Bin Osman. 26 years old. Financial Park Labuan Complex, Labuan FT.

Personal Financial Consultant Labuan Branch. "Fixed and Adjustable Rate Mortgage." 9

March 2012

Monthly Statistical Bulletin January 2012. (2012). Retrieved March 08, 2012, from Central Bank of

Malaysia: http://www.bnm.gov.my/index.php?ch=109&pg=294&mth=1&yr=2012

BIBLIOGRAPHY Mortgage. (2012). Retrieved March 09, 2012, from Investopedia:

http://www.investopedia.com/terms/m/mortgage.asp#axzz1ojdMzSKP

Norhana Endut, T. G. (n.d.). Household Debt in Malaysia. BIS Paper , 107-116.

Sirmans, C. (1989), Real Estate Finance, 2nd ed., McGraw-Hill, New York, NY.

Tan Chun Ping. 27 years old. Lucas Kong Building, Jalan Merdeka, Labuan FT. Senior Operations

Officer of Public Bank Labuan Branch. “Best Option in Mortgage.” 7 March 2012.

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Appendix

Figure 1.1

Figure 1.2

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Figure 2.1

Consumer Price Index

Weight (2010 =100) All groups100.0

2010 99.42011 101.82012 104.5

Sources from: Data & Statistics of Bank Negara Malaysia

Figure 2.2

Banking System: Classification of Loans by Type

RM million

End of period Housing

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loans

2011 11255,856.3

12258,728.0

2012 1261,303.8

Sources from: Data & Statistics of Bank Negara Malaysia

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