Examples how to better guide customers in home loan decisions

9 November 2022

The decision to buy or renovate a home, is for most people the most important financial decision in their life. Not only are the involved amounts 10 to 100 times higher than most other financial decisions, there are also many decision factors to consider. Nowadays most banking clients only make a conscious decision about the tip of the iceberg.

When asking retail customers about the main decisions to take, they will indicate the choice of the bank (determining the price / interest rate of the loan), the amount to borrow and the loan duration. However there are much more aspects to consider for making a correct and informed financial decision.

Let’s have a look at all the elements that can and should play a role in this decision process.

Defining the “home project”

First of all the “home project” should be well defined. Maybe you haven’t decided yet what your home project will look like, so it’s important to decide on aspects like:

• Am I going to buy or rent my home? This decision implies a good knowledge of the rent amount versus the mortgage amount for a similar home, how the value of your home will evolve in the coming years (potentially taking expected inflation into account), how many years do you expect to stay in your home, what are the tax implications, etc.
• Which type of home are you looking for? Constructing a new house yourself, buying a new house/apartment/studio from a project developer, buying an existing home/apartment/studio which is ready to move in or buying an existing home/apartment which requires extensive renovation? Or are you looking for more a specific housing, like a co-housing project or a houseboat? Which location? Which price range? A detached house or a terraced house? Which surface of terrain or living space? Number of sleeping rooms, bathrooms? …​ Many of those decisions do not only have a price impact, but also have tax and cash flow implications (e.g. a house to renovate allows to spread the expenses over time).
• How will you use the home? Do you own already a home or is it your first home to purchase? Are you buying the home to live in it yourself and/or will you rent it out (entirely or partially)? Will you occupy the home alone or with your partner, with your children, with other family members and/or with friends?

Defining the financing options

Once the home project is defined, the next step is to define how it will be financed? Here we need to consider aspects like

• Determine the amount you need to borrow. This will obviously depend on the price of the home and the assets you have available. The total price of the home will also be a complex calculation, taking into account elements like the price of the terrain and/or house, renovation costs, costs of the architect, taxes (e.g. VAT or registration costs), notary costs, mortgage costs, etc.
  It’s also important to consider additional short-term costs linked to the new home (live moving costs, new furniture, decoration​), your risk appetite (do you want to keep some reserve savings as a buffer or put all your assets in the home), the minimum amount the bank asks to put in the home yourself (e.g. registration costs, notary costs​) and the impact a higher personal contribution can have on the interest rate of a loan.
• Do you want to finance the home via the traditional financial system or explore alternative forms? E.g. you could also consider P2P Lending marketplaces, DeFi lending or alternative ways to acquire a home, e.g. annuity, renting/leasing the home with the option to buy it at a later date, become a shareholder of the housing project, which results in paying rent to the project and receiving dividends from the project, etc.
• Compare different banks. Here loan simulators (like Spaargids.be or TopCompare.be in Belgium) can help, but most of the time they only give the market rate (i.e. no negotiated rate), give no guarantee that you will actually obtain the simulated loan and only include the standard loans (i.e. no special conditions and usually little comparison of all value-added services – see further), so a good comparison will probably require a lot of effort from your side.
• Type of loan. When thinking about lending money for a house, most people automatically think about a new mortgage. In most cases this is the cheapest loan (both from an interest rate and tax perspective), but not always. Especially for people already having some assets, other types of loans might be interesting to consider. For example redrawing on an existing mortgage, (partially) using a consumer credit (many governments subsidize consumer credits with the aim to improve the ecological character of your home), a Lombard credit (using your existing financial assets as collateral – see Capilever’s Lombard² product), etc.
  Additionally you need to check if you need temporary financing to gap specific short-term cash flows. Typical examples can be a bridge loan (a loan to bridge the cash flow gap between buying your new and selling your old home), overdrafts, etc.​ The type of loan to take will heavily depend on your current financial situation and the tax impacts each loan will have.
• Once all this is defined, you can start playing with the duration. This allows to get an idea of the monthly reimbursement amount. Obviously the longer the loan, the more interest you will pay, but also the lower your reimbursement amount, so it’s a matter of finding the right balance between optimizing interest payments and not having excessive repayments, so that your loan does not completely control your life. Your age is also important in defining the duration of the loan. Most people (and often also the bank) will insist on having their loan terminated before their retirement age.
  For correctly defining the acceptable monthly reimbursement amount, it is important to create a budget of incoming and outgoing cash flows. Here you also need to consider the extra recurring costs linked to the (new) home, like fire/theft insurance, outstanding balance insurance, cadastral income tax, (higher) utilities costs (water, electricity, gas​), maintenance costs (e.g. cleaning of boiler, garden), etc.
• When the above aspects are defined most people will take a decision, but obviously the interest, reimbursement and pay-out scheme will also be extremely important. Depending on the type of loan, country and bank, different schemes exist. For reimbursements we can make a distinction between simple (equal) monthly installments, a balloon loan, a bullet loan, monthly installments which increase over time (e.g. with a fixed expected inflation rate), monthly installments which decrease over time as each installment repays a fixed amount of capital (and as interests decrease the total reimbursement amount decreases).
  For the interest rate conditions, we can identify a fixed interest rate and all kinds of flexible interest rates, like revisable each year, every 3 years, etc. and with different floors and caps which can protect both parties against future changes in the Central Bank’s interest rates.
  For the pay-out (receiving the funds) a few options also exist. Usually you will get all borrowed funds at once, but there are also constructions where the borrowed funds will be received in parts (e.g. each time invoice linked to building/renovation of home is delivered to the bank).
• The next step is the definition of the collaterals and guarantees linked to the loan. The first question here is to define who the borrowers are (are you borrowing alone, as a couple, etc.​) and in which division (if applicable). Apart from the borrowers itself, it might be that other persons (e.g. parents) are guaranteeing the loan as well.
  Often banks will enforce to sign a document allowing them to seize directly outstanding loan amounts from deposited salaries. This is also a reason why many banks request you to have a current account with them where your salary is paid.
  The type of collaterals typically depend on the type of loan. In case of a standard mortgage, the home will be the collateral itself, but other collaterals can exist as well, such as securities, life insurances or the mortgage on another home. Additionally it can be discussed not to take a mortgage for the entire loan amount, but a percentage. This increases the risk for the bank, but can be interesting for the borrower, as legal registration costs are often a percentage of the mortgage amount. In some cases, the bank will request however to sign a mandate for the “uncovered” remaining percentage, which allows the bank to automatically take a mortgage on the remaining percentage, in case of repayment issues.

Value-added services on top of the financing

If the details of the loan are fully clarified, it is important to discuss all value-added services on top of the financing. Often these are coupled to the loan, meaning you obtain a better interest rate if you take those products at the same bank. This makes comparing loans at different banks even more complex, as those value-added services do not have the same price and level of quality at different banks.
Examples of such value-added services are:

• The need to open a current accountat the bank where for example your salary is paid. Obviously such a current account comes with certain costs and interest rates (for some debit and credit) and potentially also specific services, like a debit/credit card, specific account insurances and/or rewards (like cash-backs) on transactions happening on the account
• Fire/Theft insurance: As for any non-life insurance it is important to compare the premium amounts, the total insured value (and how it evolves or needs to be adapted if you improve your home or better decorate your home), which risks are covered (like fire, theft, flooding, vandalism​), how the claim process is organized, if you get added-value services like legal assistance for legal matters related to your home, etc.
• Outstanding balance insurance: this repays the outstanding balance in case the insured person deceases. Also for this insurance different options exist, like repayment of 100% or a lower percentage of the outstanding amount, same or different insurance for each borrower, additional insurance against disability, illness and/or unvoluntary loss of job, possibility to pay the insurance amount per month, per year or pay in full at the beginning.
• Solutions to manage the inheritance. This can be interesting in case of more complex inheritance situations (like blended families or for a single person without direct inheritors), but also to ensure the longest living partner (also living in the home) is sufficiently protected.

What-If scenarios

Once all this information is gathered, it is important to simulate different What-If scenarios, to see what the impact is on monthly reimbursement amount, taxes and the affordability of the loan.
Typical scenarios to simulate are:

• Decease of one (or more) of the borrowers
• Serious illness of one (or more) of the borrowers (typically resulting in decrease of revenues and an increase in costs)
• Loss of job of one (or more) of the borrowers
• Divorce requiring selling the home or one of the borrowers paying out the other borrower (and continuing loan repayments alone)
• Early selling of the home (e.g. within 5 years, within 10 years​)
• Desire to refinance the loan, i.e. in case interest rates have dropped considerably or in case you want to increase/decrease the monthly reimbursement amount. Important here is to balance the penalties linked to the refinancing with the potential benefit obtained from the refinancing
• Desire for an early repayment, i.e. desire of borrower(s) to early repay the outstanding balance partially or in full
• Evolutions (increase/decrease) of the Central Bank’s interest rate and how this impacts your monthly reimbursement amount
• Evolutions of inflation rates over the duration of the loan and how this impacts the discounted monthly reimbursement amount
• A bankruptcy, take-over/merger or decision to stop business of the borrowing bank. What happens with the conditions of my loan at that moment?
• …

More guidance can be given

As you can see there are dozens of aspects to consider, for which banks rarely provide the necessary tooling to assist their customers. Given the importance of a home loan for most retail customers, we feel there is still room for improvement to offer more guidance to customers in the above financial decision-making process.
Via (dynamic) questionnaires, wizards, real-time simulations (allowing to simulate different What-If scenarios) and Q&As, a bank can become even more a trusted partner in this process, which will result in a strong competitive advantage towards other banks. If you know that a mortgage is a very sticky product – if done well the customer will be bound to the bank for 20-30 years – with lots of options to cross-sell other products, we would definitely advise banks to invest more in this guidance.