In contemporary Saudi Arabian economy, demand for residential housing is on the rise; according to a Saudi Arabia Housing Sector Outlook, the economy’s demand for new housing is expected to grow at a rate of 18% per annum during the period of 2010 to 2013.
The report further clarifies that by 2015, the country is in need of 1.65 million new residential units. With the hiked demand for housing, the mortgage industry has grown drastically: banking and financial institutions are tapping these markets and developing effective means to mitigate losses as a result.
Demand for housing has grown due to an increasing youthful population that is setting small families at younger age; the country has a high population growth rate having doubled for the last forty years to 28.7 million, all these people have lead to the growth of the housing industry (Saudi Arabia Economic Statistics and Indicators). This paper discusses the countries mortgage business trends.
Borrowers risk and residential mortgage lending
Residential mortgage lending means housing financing of homes; this is where a borrower takes a loan facility in the form of a mortgage to buy or construct a house to live in. The main difference that the facility has with commercial leading is that the bought house is expected to be the living premises of the borrower and not rented out for business purposes.
The sector is the fastest growing in Saudi Arabia where young people are looking for homes to buy, or be financed to be build one. With the rise in demand of residential mortgage lending, and the need to make them affordable and protect the lenders, Shura Council has developed some lending policies.
An amendment was passed in April 2011, where the countries housing authority was upgraded to a full ministry and expected to use $67 billion to build 500,000 homes; the ministry is expected to have a budget of $4 billion.
In Islamic banking, of which are the majority in Saudi Arabia, residential mortgage lending follows regulations of SAMA; it happens that the lender engages into a contract by a third party, buys the house and rents the house to the customer. The amount of rent will have an element that goes to the bank as a gain from investment what is the financial benefit to the bank and another amount that goes to the principal amount.
When lending banks and other financial institutions under the regulations of SAMA have a structure that works as the contract between the lender and the borrower; the contract is made with the prevailing condition at the time of lending taken to task; however, the situation may change creating some difficulty in the honor of the payment agreement.
Any change or chances of a change that might result to strained payment or default is called borrows risk. Borrows risk can thus be defined as the chances at which a borrower will default (willingly and unwillingly) paying the loan (Raymond, Ying-Foon and Ming 5-32).
Factors you think are relevant in determining borrower’s risk
When offering loans, a bank has to gauge the chances of success of the loan; the same happens with mortgage financing; the following are the factors that need to be considered:
- Borrowers Information
When evaluating a borrower financing institutions/lenders considers the current and historical information of the lender, SAMA maintains a credit, history software were lenders are supposed to run the information of the borrower with the system and the history of the borrower will be offered.
A high relationship exists between a person who have defaulted in the past and the chances that they are likely to default in the future. Those people who have had a history of defaulting are given the facilities with more restricted terms or denied all together.
Other than the government records, in case someone is an employee, the reputation of the company he is serving should also be looked into, there should be a letter signed by the employer guarantee the loan facility (Sfakianakis and Banque).
- Property Information
When offering a facility, the property that is being mortgaged will be the subject of the contract; the lender values the property and determines the amount of money he is going to offer the property.
The main concern here is that there should be value for money, properties should not be over or undervalued. When looking at the value, there should be respect to local government and ministry of land instructions regarding the amount that the property should cost. The contract should ensure that there is mutual benefit on among the two.
- Loan information
Depending with the facility that a financier is offering, the nature will take different forms; loans are made with different packages to meet the demands of different categories of people.
With increase in competition in the industry, every company is looking for the best ways it can sell to the larger community; on the other hand, the government through housing authority is seeking to improve the affordability of the facilities; it also ensures that businesspersons do not take advantage of the situation.
When lenders are gauging the potential of a borrower, they consider what the borrow can afford, they put into consideration other loans that he might be financing, his living standards, his responsibilities and try to determine the amount that can be committed to the mortgage.
This assists in ensuring that when someone id financing a facility, he is not pushed to the wall that he can decide to default payments. It is also SAMA rules that someone should commit his income to financing of loans only to a certain percentage. Side incomes are also considered (Zainab).
Relationship between the three types of borrower’s risk and residential mortgage lending
The above risks have interrelations and connections; when one area is overlooked, then it is likely to be the weak point of the whole process.
In case the lenders observes that the prospective borrow has the potential and have good credit history, as it is required by borrowers information, then goes ahead to advance a facility without looking into loan information of the borer, then the borrow is likely to default paying the loan because he has been constraint by financial budget.
On the other hand, loan information and property information are found to be okay but the lender overlooks borrower’s information; it is risking chances that the borrower has just made things look better but he is a defaulter.
All the risk analysis tools through seeking information should be considered before advancing a loan facility to a borrower (SAMA).
Global financial crisis and Saudi Arabia’s Real Estate sector
According to Saudi Arabia’s commercial Real Estate sector report for the third quarter in 2010, the effect of global financial crisis was more felt in real estate’s industry than it was felt by the entire economy; the sector of the economy has been responsible for the growth of mortgage industry. The economy faced a reduction in business in the real estate of up to 10% where rental and the value of housing reduced accordingly. Global crisis brought about a contraction in lending rates in banks thus the demand for real estate’s also went down. People could hardly have enough money to demand for homes. In 2010, the situation seemed to have taken a different route while the government focused on a boost in the industry other than the traditional oil industry (Gulf base).
The growing population of Saudi Arabia and improved living conditions in the country is offering an opportunity for residential mortgage business; however, some measures that should be enacted by lenders to ensure they benefit from the opportunity, they include:
Although Saudi Arabia is more of a capitalist nation, lenders should ensure they do not overprice their mortgages since there is high demand for the youths. Demand is higher than supply and according to law of demand, the prices should increase, as much as this is true, lenders should go ahead further and consider value for money. They should not overprice and take advantage of the high demand.
Learning from experience is important since the failure of the United States mortgage industry in 2007 was because of unjustified increases in mortgage prices. I would recommend my bank to consider the borrower and value for money; this will lead to continued flow of customers.
The next important factor that the bank should look into is the historical background of the borrower, the credibility of the borrower should be proved beyond doubtful doubts. In case of a red flag, the company should hold back and analyze the situation.
To be sure, of credibility, third parties like employers, other bank’s statements, spouse consents, and utility bills holders should be consulted. With globalization, I would develop flexible mortgages facilities that allows for restructuring of loans; however, it should be in accordance to SAMA regulations.
Gulf base. Kingdom Of Saudi Arabia. GCC Stock Market, 2010. Web. 17th May 2011.
Raymond, Chiang, Ying-Foon Chow, and Ming Liu. Residential Mortgage Lending and Borrower Risk: The Relationship between Mortgage Spreads and Individual Characteristics. The Journal of Real Estate Finance and Economics 25.1 (2002): 5-32. Print.
SAMA. Saudi Arabian Monetary Agency. Saudi Arabian Monetary Agency, 2010. Web. 17th May 2011.
Saudi Arabia Economic Statistics and Indicators. Economy Watch. 2010.Web. 2h 17th May 2011.
Sfakianakis, John, and Banque Fransi. Saudi Arabia Economics. Web. 17th May 2011.
Zainab, Fattah. Saudi Arabia’s Mortgage Law Advances Amid Mideast Unrest. 2011. Web. 17th May 2011.