Falling mortgage rates spur activity

It started in early 2010, with Standard Chartered offering a 6.5 per cent rate to customers seeking to roll over mortgages. This was followed by HSBC reducing rates from 8.5 to 6.75 per cent for first-time buyers. Other banks which reviewed and reduced rates included RAKBank, Mashreqbank and Abu Dhabi Finance, which made the biggest cut to 5.75 per cent.

This year has witnessed a similar phenomenon, with HSBC recently cutting rates by 76 basis points to 5.49 per cent. Less than a fortnight later, new entrant United Arab Bank announced an inviting 4.99 per cent rate for loans with a loan-to-value of 85 per cent.

On resuming lending in October, Tamweel offered a 5.75 per cent profit rate, which it has now reduced to 4.99 per cent. Standard Chartered is offering rates starting from 5.49 per cent with tenors as high as 30 years and loan amounts of up to Dh18 million.

It is quite interesting to analyse what impact this has had on the market since most commentators are convinced about the inverse relationship between interest rates and property prices. The rationale is that the reduction in mortgage rates brings obvious savings to the mortgagee, resulting in more people opting to purchase property, thereby increasing the number of transactions and subsequently raising sale prices.

The reality is not as straightforward.

Substantial savings

Our analysis shows that every 50 basis point reduction in the mortgage rate results in a 4-5 per cent reduction in monthly instalments and an 8-11 per cent decline in the total interest paid over a 25-year loan. Given that the total interest paid over the period constitutes around 100 per cent of the original loan amount, a 10 per cent reduction equates to substantial savings.

However, with the maturing market, investors and buyers are looking at the broader picture.

One of the major factors homebuyers are looking at is the current rentals. If rental yields are lower than mortgage rates, residents will be better off leasing since monthly outflows in the form of rents will be lower.

On the other hand, if interest rates are lower than the rental yield, the monthly loan instalments will be lower than rents, providing an incentive to residents to buy rather than lease.

Dubai and Abu Dhabi

In Dubai, rental yields have fallen to between 6 and 9 per cent, whereas in Abu Dhabi yields are higher as a result of the higher rents, ranging between 8 and 10 per cent. As such, a reduction in mortgage rates will impact Abu Dhabi much more than Dubai, since tenants will start exploring the benefits of paying lower monthly instalments rather than the current high rents.

As such, any mortgage rate below 8 per cent will be attractive to Abu Dhabi residents, while anything below 6 per cent can find favour with Dubai residents, though it should be noted that the former's supply issue may nullify the impact of rate cuts.

It should also be noted that in many other markets people opt to buy rather than rent because the interest they pay on a mortgage is tax deductible, and another consideration in people's decision to buy is that they believe the asset will appreciate in value.

Moreover, it is not possible to really compare Dubai and Abu Dhabi since banks in the former do not currently finance off-plan sales and Abu Dhabi's average loan request is reportedly double that of Dubai's. Further, while Dubai rates are presently lower than those in Abu Dhabi, LTVs in Dubai are considerably lower.

The writer is the head of valuations and research at Chesterton International.