1.0 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 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%.

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

2.1 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 banks 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. 2.2 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. 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 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.

2.3 Fixed rate and adjustable rate mortgage, which is preferable? This question will come up mostly when people looking to buy a home. When they look at the banks 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 shortterm 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.

Base Lending Rate

6.80 6.60 6.40 6.20 6.00 5.80 5.60 5.40 5.20 5.00 4.80 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 2009 2010 2011 2012 Base Lending Rate

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, riskaverse 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. 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 5

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.

3.0 Factors determining a mortgage selection 3.1 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.

3.2 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, 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.

3.3 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. 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.

3.4 Current base lending rate and offer rate by lenders

Percent per annum Average rates during the period 2010 1 2 3 4 5 6 7 8 9 10 11 12 2011 1 2 3 4 5 6 7 8 9 10 11 12 2012 1 Base Lending Rate 5.51 5.51 5.76 5.76 6.02 6.02 6.27 6.27 6.27 6.27 6.27 6.27 6.27 6.27 6.27 6.27 6.54 6.54 6.54 6.54 6.54 6.54 6.54 6.53 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.

3.5 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.

4.0 How do you borrow a mortgage? Basic steps you should go through in the mortgage loan process. 4.1 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 prequalification application, such as the property purchase price and down payment amount. Getting preapproved can help show home sellers you are a serious buyer. 4.2 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. 4.3 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. 4.4 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. 4.5 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.

4.6 Loan Review Process After the appraisal, the loan file is submitted to the lender for your loan to be reviewed. 4.7 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. 4.8 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. 4.9 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. 4.10 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.

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

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