Principles of Mortgage - Part 1

What is Mortgage?

Most people understand a mortgage to be a home loan. The technical definition, however, is a bit more complex. A mortgage is actually a loan in which you, as the borrower, offer your property and land (the title) as security until such time as the loan (principle plus interest) is repaid, say 10, 15 or 25 years down the line.

The property and land you offer as security is actually what you're buying. Once repaid, the title of the property is returned back to the borrower. The word comes from the French meaning 'dead pledge'.

Four Basic Components of Mortgage Calculations

Mortgage calculations always involve four basic variables, namely Principle, Interest, Term, and Repayment:

1. Principle: Amount of money borrowed.

2. Interest: Money a borrower pays for use of money (principle) or money a lender earns for lending the money.

3. Term: Life of a mortgage contract. A the end of this period, the contract is over and the amount of the remaining principle becomes due in full.

4. Repayment: Regular payments to be repaid at preset intervals, such as weekly, bi-weekly, monthly, and etc. Monthly interval is most commonly used. Amount of repayment is calculated based on the principle amount, interest rate, and term given to pay off the entire principle. Every repayment is made up of two portions: principle and interest. The principle portion reduces the original amount borrowed. Whereas the interest portion is the money a borrower pays for use of money.

When a mortgage is set up, four basic components above will determine how much total interest a borrower has to pay. The shorter the term given to pay off the principle, the less the interest the borrower has to pay. However, the shorter the term is, the higher the repayment amount is required.

The length of time used to determine repayment amount is called Amortization Period. The period can vary from 10, 15, to maximum 30 years (some banks in Malaysia starts to offer up to 40 years term). If a borrower is given a 30-year term and every repayment is made in time without extra prepayment, he/she will completely pay off the mortgage after 360 payments.

Each payment consists of principle and interest. At the early stage of the amortization period, money from each repayment made mostly goes towards interest, very little goes towards reducing principle (see amortization schedule 1). Over time, the trend reverses whereby money from each repayment made mostly goes towards reducing principle, very little goes towards interest (see amortization schedule 2).

Mortgage Glossary

Adjustable Rate Mortgage (ARM)
A variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate on the outstanding loan amount is periodically adjusted based on what is specified in letter offer.

Amortization
Literally to "kill off" the outstanding balance of a loan by making equal payments on a regular schedule (usually monthly). The payments are structured so that the borrower pays both interest and principal with each equal payment.

Balloon Mortgage
Behaves like a fixed-rate mortgage for a set number of years (usually five or seven) and then must be paid off in full in a single "balloon" payment. Balloon loans are popular with those expecting to sell or refinance their property within a definite period of time.

Balloon Payment
The final lump sum that is paid at the end of the balloon mortgage.

Default
The failure to make payments on a loan.

Down Payment
Money paid by a buyer from his own funds, as opposed to that portion of the purchase price which is financed.

Early Exit Fees
A penalty for ending (full settelement) a mortgage during a lock-in period (fixed/discounted interest rate period). Many mortgage lenders in Malaysia charge a percentage fee (normally 3% or 5% and subject to a minimum amount) based on the original loan amount. Early exit fees are also known as exit fees or redemption fees.

Fixed-Rate Mortgage (FRM)
A mortgage where the interest rate does not change for the life of the loan.

Grace Period
A time allowed, for making late payments without a penalty.

Interest
Money paid for the use of money, usually expressed as an annual percentage.

Interest Only
A term loan arrangement calling for payments of interest only, not to include any amount for principal.

Interest Rate
The percentage of an amount of money that's paid for its use over a specified time period.

Loan
The principal, or amount of total borrowed money, that is repaid with interest.

Loan Amount
The amount of money that you intend on borrowing from a financial institution for the purchase of your home. Subtracting the down payment from the purchase price of the home will provide you with the loan amount.

Lock-in Period
A period normally with fixed or discounted interest rate prohibiting loan borrower to fully settle a mortgage. Exit exit fees are applicable in the event that the loan borrower ends the loan within this period.

Lock-in Clause
Clause in a loan agreement that states that the borrower cannot repay a loan prior to a specified date.

Maturity
The "Due Date" of a loan.

Mortgage
A legal document that pledges property to a creditor for the repayment of the loan, and is the term used to describe the loan itself.

Mortgagee
The lender in a mortgage agreement.

Mortgagor
The borrower in a mortgage agreement.

Mortgage Reducing Term Assurance (MRTA)
MRTA is used to protect against the outstanding balance of housing mortgage in the event of the loan holder’s unexpected death or TPD (Total Permenant Disability), the loan will be settled. The MRTA is a reducing term life assurance whereby the sum assured reduces in accordance to the scheduled outstanding loan amount.

Partial prepayment
Making a payment larger than the scheduled payment as a way of paying off the loan earlier.

Prepayment
Any amount paid so as to reduce the principal before the due date.

Principal
The amount of debt, not counting interest, left on a loan.

Refinance
The process of paying off one loan with the proceeds from a new loan, using the same property as security.

Miscellaneous questions

How does mortgage reduction request affect my MRTA policy?

After you have fully settled your shorten mortgage term, you can write in to your MRTA insurance company for a refund. For example, a original MRTA policy which covers a 30-year term, the policy holder can claim refund for a 17-year coverage if his/her loan has fully settled in 13 years (shorten by 17 years through mortgage reduction service).

Does mortgage reduction service involves change of existing housing loan package?

No. Mortgage reduction service does not involve any changes on housing loan package of a loan borrower.

Is mortgage reduction service legal and accepted by the financial institutions?

Certainly. The service is permitted under Malaysia Banking and Financial Institutions Act 1989 (BAFIA Act), which is governed by Central Bank of Malaysia (Bank Negara).

My mortgage is still within lock-in period, can I engage with mortgage reduction service without having to pay the early exit fee (penalty)?

Certainly. As long as your mortgage is not fully settled within the lock-in period, the penalty will not be applicable.

Does mortgage reduction service involve refinancing of loan to another financial institution?

No. Mortgage reduction simply involves rescheduling of prepayments. No refinancing is required or involved.

What happen if my mortgage lender rejects my mortgage reduction request?

If your mortgage reduction request is made through a Supex mortgage reduction consultant, your request shall be definitely accepted by your mortgage lender. The financial institutions in Malaysia have no legitimate reason for denying the basic rights specified in the BAFIA Act.

Does mortgage reduction service involve amendments to existing legal documents which incur additional legal charges (such as stamping fee, and etc.)?

No. Mortgage reduction request only involves rescheduling of future prepayments, no legal documents are to be revised or amended.

Mortgage Reduction DIY Checklist

You can use the simple check list below to see if you are capable of performing Do-It-Yourself (DIY) mortgage reduction correctly:

1. Do you know how to generate an up-to-date amortization schedule for your loan to ensure that the outstanding balance printed on your account statements is correct?

2. Do you know how to compute how much interest you can save and how many months of repayment can be shorten with the new prepayment that you intent to reschedule?

3. Do you know how to double check to ensure that your mortgage lender has duly executed your prepayment request as promised?

4. Do you know how to correctly interpret the prepayment clause printed in your loan agreement? Do you understand the implications of restrictions set in the prepayment clause?

5. Do you have the negotiation power in negotiating a new partial prepayment arrangement with your mortgage lender? Your right might be denied simply because you are not knowledgeable enough in the topic that your are dealing with.

6. Do you know how to ensure that your mortgage lender do not intentionally delay your request? Delay in execution of partial prepayment could result you in paying many months of extra interests.

7. If you request have been denied or delayed without legitimate reasons, do you know how to file a complaint to the higher authority for further action?

8. Do you know how to make prepayment notice (could be 1-month or 3-month in advance) consistently to your mortgage lender for every prepayment made throughout your loan tenure?

9. Are you afford to prepay the minimum prepayment amount set in the prepayment clause (normally in multiple of thousand of dollars)?

If your answer is YES to ALL questions above, then you can capable of making prepayments correctly.

What is mortage reduction service?

Mortgage reduction service helps loan borrowers save thousands of dollar in mortgage interest by making partial prepayments with a detailed Mortgage Reduction Plan (MRP). The MRP contains amortisation schedules illustrating how partial prepayment rescheduled by a lump sum prepayment or monthly prepayment.

When a loan borrower decides to engage with the service, her/she will appoint a mortgage reduction consultant by authorising the consultant to liaise with his/her mortgage lender on behalf of him/her on the execution of MRP.

All bank allows loan borrower to make prepayments, why I do need to engage a consultant?

You are absolutely right. All housing loan agreement allows loan borrower to make prepayments. However, most of the loan borrowers are misled by the mortgage lender when it comes to making repayments (please refer to Types of Repayments for details). You do not need a mortgage reduction consultant if you are absolutely sure how to prepay correctly (please refer to Mortgage Reduction DIY Checklist).

How long does a mortgage reduction service take to complete?

Depending on the prepayment notice, it normally takes 3 (for 1-month prepayment notice) to 6 months (for 3-month prepayment notice) to complete. The entire process flow includes collection of copies all relevant documents (Letter Offer, account statements, loan agreement, and other correspondence from the financial institution and developer), preparation of MRP, revision of MRP (if any), submission to the financial institution, and reminders for MRP execution (if required).