The importance of ancillary services for residential mortgage borrowers in default in Sri Lanka

Abstract

1. Introduction The demand for housing and housing finance is high and this basic need should be addressed by society. This study aims to provide insights into the loan customer’s use of ancillary services in relation to mortgage loans and the effects of the use of ancillary services on loan default in the Sri Lankan residential mortgage market. In general housing loan customers may not be fully aware of related matters such as financial, legal, technical, social and economic factors. The broader objective of this study is to be aware of loan customers’ perceptions of the ancillary services offered by mortgage loan suppliers and the implications of taking up these services for mortgage default. Further, it aims to identify the importance of the mortgage loan counseling service for the mortgage market in Sri Lanka. Typically, banks and other financial institutions assess the risks of housing loans on the basis of loan features (term to maturity, interest rate, size of down-payment), borrower financial characteristics (income, total debt, credit limit), and the value of the property pledged as collateral. These are all important measures affecting the probability of recovery of mortgage loans granted by lenders. Further, there are some other measures which are important and contribute to timely loan servicing by the customers. The financial abilities of customers are relevant influencing factors in relation to servicing a housing loan which is usually a long-term transaction. Further, customers have to have competence to cope with economic and political changes and with managing day to day activities while loan obligations are met. Unfortunately, there are currently no studies being conducted of mortgage counseling specifically designed to meet these needs Lind, (2011). In the local mortgage market, one can notice large variations in interest rates within the last few years and further considerable rate variations between loan suppliers in the market. In the beginning of 2009 market interest rates on mortgage loans were at around 19.5% and varied over the period up to 2013 down to 12.5% at bottom. This is an immense change to interest rates for transactions of this nature. However, the prevailing interest rate is still high when comparing it with other mortgage rates in the region; around 10% in India, around 7.5% in China, and around 5% in Malaysia. This study has focused on one important pillar of the housing finance market in Sri Lanka. This follows a survey of borrowers in order to examine their views on ancillary services provided by mortgage lenders before and after loan disbursement. While housing finance is a vital component of a finance system of a country, there has not been a systematic analysis of loan counseling across the country. Among others the ratio of average value of a house and the time it would take a borrower to pay that full value out of their irregular earnings is an important measure of their ability to afford a mortgage loan in the market. Analysis of the labor force also reveals that only around 20% of the population is in regular employment. Among existing lowincome loan holders, poor recovery rates have been a major problem. Default on a housing loan is usually a result of a significant and unexpected event which ultimately affects both the financial institution/ loan provider and the borrower. The borrower may not have the capability to manage such incidents but financial institutions should take more responsibility in counseling/guiding customers and supporting them in relation to the issues they are facing. This should cover the financial, insurance, legal and technical/engineering aspects of house construction under mortgage arrangements and therefore the loan provider has to play a wider role beyond only acting as a financial institution that provides a loan. On the other hand in practice it is not easy to evict borrowers and realize collateral, given the social and cultural values of the society although loan providers have all legal powers for recovery of losses through insurance or foreclosure. As a result of this situation, lenders must think twice about the implementation of parate rights (that is, the ability of a lender to foreclose and sell a property where the mortgage loan is in default, without going to court). This was mentioned by Ahmed et al.(2007). As yet the effectiveness of foreclosure is hampered for most lenders by weak eviction powers. In this situation a pre-planned loan counseling service may help to minimize default by building links between borrowers and their lenders. It might help to cultivate financial literacy/discipline among loan customers and to find solutions to other issues/ problems they may have, if they work together to identify potential solutions to problems arising for borrowers when a loan payment is due.