Who’s to blame for low mortgage uptake?

A Central Bank of Kenya report singles out bank’s fixation with variable interest rates for blame, but experts argue volatile interest rates make it difficult for lending institutions to have fixed interest rates, writes FRANCIS AYIEKO

An attendant at a bank’s stall at the Kenya Homes Expo held last month was at pains to explain to a visitor why their mortgage interest rates were variable.

The man had walked to the stall and asked for a mortgage repayment schedule. After scrutinising the document for about one minute, he turned to the lady at the stand and asked whether the rates were fixed or variable. “Variable,” she said and quickly added: “The interest rates have been too high to fix.”

At the expo, six major local commercial banks showcased their mortgage products. The common feature in those products was that they all offer variable mortgage rates, which change with the rate of inflation or the state of the economy.

A few, however, offer up to five years part fixed mortgage rates. This means the interest rates do not change for the first five years of the loan, after which they revert to variable terms for the remaining life of the mortgage.

Because of unpredictable economic environment, that is often prone to inflationary pressures. Banks in Kenya generally offer mortgage loans on variable terms, which allow them to adjust the rates upwards when the economy becomes volatile as happened from 2011 into the early parts of last year. This was in response to the increase in base lending rate by the Central Bank of Kenya. During that period, interest rates went as high as 25 per cent.

Whereas such flexibility may have worked for lenders, borrowers, however, felt — and many still do — the real pinch of interest rate spikes during that period.

According to a new survey by the Central Bank of Kenya, the high interest rates in the first half of last year impacted negatively on the mortgage market with non-performing loans increasing from Sh3.6 billion in December 2011 to Sh6.9 billion in December last year.

“The interest rate charged on mortgages was 18 per cent on average, and ranged from eleven per cent to 25 per cent,” says the report titled, Bank Supervision Annual Report 2012.

It says 85.6 per cent of mortgage loans were on variable interest rates basis, down from 90 per cent in 2011. In 2010, 73 per cent of mortgage loans were on variable interest rates.

“The tendency for financial institutions to grant mortgage loans on variable interest rate basis may be contributing to slow growth in residential mortgage market in Kenya,” the survey, said.

According to the report, Kenya had a total of 19,177 mortgage accounts by December last year, up from 16,029 in December 2011. The value of outstanding mortgage loans increased from Sh90.4 billion in December 2011 to Sh122.2 billion in December last year, representing a growth of Sh31.8 billion or 35.2 per cent.

Average loan size

On the other hand, the average mortgage loan size increased from Sh5.6 million in December 2011 to Sh6.4 million in December last year. The increase, says the report, may be partly attributed to increase in property prices.

Although the report does not say exactly how many borrowers defaulted on their monthly repayments, a simple calculation (dividing the value of non-performing mortgage loans, which is Sh6.9 billion in this case, by the average mortgage loan size, which in this case is Sh6.4 million) gives the number of defaulters as 1,078, on average. That number was 764 in December 2011.

Financiers have acknowledged that last year (and even 2011) was tough for mortgage holders. However, they have been quick to point out that they managed to put in place measures that mitigated against ‘massive’ default.

“Inflation ate into people’s disposal income and saw interest rates rise to as high as 24 per cent. As a result, many customers had a problem keeping up with their monthly repayments,” said Joram Kiarie, director of mortgage business at the Kenya Commercial Bank.

He said that to help their customers cope, they restructured the mortgage loan facilities by extending repayment periods, hence reduced monthly repayments. The highest rate the bank charged during that period, he said, was 19 per cent.

But did they experience default cases during that period? “We had a few cases where we had to sell people’s property because they could not pay either because of high interest rates, or because of loss of employment. The circumstances varied, but I can tell you it was not serious,” Kiarie said, noting that “we only sell in extreme circumstances” and that they give customers time to adjust during hard times.

The Land Act enacted last year stipulates that in case of default, the lender must get the highest (full market price) for the distressed property. If this is not possible and the lender is forced to sell through an auction, then the property must never be sold below 75 per cent of the prevailing market price.

This is meant to ensure that even in the event of an auction because of default, a property owner would still be able to settle the outstanding debt and get some money on top.

Property sale

“We do that a lot when we realise the borrower can no longer keep up with the monthly repayments for whatever reason,” says Family Bank’s head of mortgages, George Laboso.

He affirms that once they recover the outstanding balance from the sale of the property in question, they hand over whatever remains to the owner.

But the fact is that we would not get there, in the first place, if interest rates were predictable. In its report for the first quarter of 2012, The Mortgage Company noted that funding of mortgages is today done primarily through bank deposits, making the industry vulnerable to shifts in short-term market liquidity.

Impact

“The impact of this cannot be underestimated with the interest rates in the market moving in October 2011 from an average of 14 per cent to 24 per cent, leaving many mortgage takers in distress after their mortgage payments doubled,” said the report, which called for a long-term and sustainable solution to funding of mortgages “to give lasting solution to this challenge”.

According to Stephen Omengo, the chairman of the valuation and estate management surveyors chapter of the Institution of Surveyors of Kenya, many people get into mortgage deals without knowing the implications of a variable or fixed mortgage rates.

Omengo, who is also an assistant director and senior valuer at Tysons Ltd, says volatile interest rates make it difficult for most banks to have fixed interest rates.

“I don’t believe in fixed mortgage rates because banks set their rates pegged on the prevailing CBK’s base lending rate,” he says.

However, he notes that financial institutions are exploiting borrowers by keeping their rates as high as 18 per cent whereas the prevailing CBK base-lending rate has been reduced to 8.5 per cent.

Omengo says fixed rate gives a borrower a level of confidence because they can predict how much they will be required to pay over a long period of time. Variable rate, on the other hand, he said, “causes uncertainty because you don’t know what will happen in future”.

“With variable rate, you are at the mercy of the lending institution,” he adds.

He says that when starting off mortgage business a few years ago, some banks were using fixed rate mortgages as a selling point, which is no longer the case today. He says a blend of fixed and variable mortgage rates would be ideal for a fledgling mortgage market like Kenya’s.

According to the World Bank, the choice of whether to levy fixed rate or variable rate interest in a given market largely depends on the inflationary environment: Both the level and the volatility of prices and interest rates.

World Bank’s take

In a publication titled, Housing Finance Policy in Emerging Markets, the global lending institution says that fixed-rate mortgages are most suitable for low to moderate and stable inflation and interest-rate environments. In such environments, the premiums for expected inflation and its variability are relatively low and stable. In higher and more volatile inflation environments, says the World Bank, fixed-rate mortgages become either prohibitively expensive or too risky for lenders to offer.

And as if talking about the Kenyan situation where almost 90 per cent of mortgages are offered on variable interest rate terms, the World Bank publication notes that the adjustable — or variable —rate mortgage is the most prevalent in the world.

“Their popularity derives from two characteristics: Depository lenders lessen their interest rate risk by offering variable mortgage rates, and borrowers improve initial affordability with variable mortgage rates because of the relatively low starting rate,” it says.

Warning

But it warns: “For borrowers, it is somewhat of a gamble that their income will keep pace with payment changes, meaning that adjustable-rate mortgages (ARMs) are not suitable for all borrowers (that is, borrowers with unstable or fixed incomes) or high inflation economies.”

ARMs, it adds, are well suited to moderately inflationary environments where interest rates, prices and incomes move together with modest changes. They are more problematic in high-inflation environments characterised by large interest changes and sluggish income change.

“The ability to change the interest rate makes ARMs appealing to lenders, as they allow them to better manage interest-rate risk, particularly for banks with short-term deposit funding,” says the World Bank report.

Such flexibility, however, might not benefit the Kenyan mortgage borrower much if the economic environment remains unpredictable and volatile. It might, therefore, not come as a surprise if the number of mortgage defaulters jumps substantially from the current 1,078 come next year.