October 10th, 2013 -- The financial crises which started in developed nations in 2007 have had devastating impact on the financial sector the world over. Closer to home in the Eastern Caribbean Currency Union (ECCU), financial and non-financial institutions in the primary lending market have been negatively affected by increases in Non-Performing Loans (NPL’s).
While NPLs are not a new phenomenon in the banking industry, it has certainly taken centre stage in the primary lending industry in the ECCU. Lending institutions are now required to make greater provisions for “Bad Debt” or Non-Performing Loans. Customers are finding it much more difficult to meet their mortgage commitments. There is need to find a workable solution or balance under these circumstances. Primary lenders are certainly not in the business of selling people’s property. They would prefer not to have to foreclose on anybody’s property. Borrowers also have a critical role to play by keeping in touch with the lender at all times, especially at the first signs of trouble in meeting their commitment. Lenders are always willing to work with their customers.
A Non-Performing Loan is a loan that is in default or close to being in default. Many loans become non-performing after being in default for 90 days, but this can depend on the terms.
A loan is nonperforming when payments of interest and principal are past due by 90 days or more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by agreement, or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full.
The million dollar question is:
How can financial institutions and customers minimize the occurrences of high NPLs?
I wish to posit that a loan does not suddenly become non-performing. The quality of the mortgage underwriting practice/standard has a lot to do with the eventual outcome of a loan. It is accepted internationally that there are four (4) main steps in assessing a loan application.
They are:
• Assessing the borrower;
• Assessing the property;
• Assessing the market; and
• Risk synthesis analysis.
If the underwriting policies and practices of lending institutions are weak or deficient, that too can contribute greatly to the increase in the instances of non-performing loans. Each of the above mentioned assessment must be thoroughly investigated. No one step on its own should be a determinant factor in the loan approval process.
At the end of the assessment process a decision must be taken based on the merit of the assessments.
Additionally, the necessary safeguards or remedies must be built in the mortgage offer letter to mitigate possible unforeseen circumstances. For instance, such safeguards or remedies include adequate life insurance, fire and peril insurance, salary assignment, good title deed or certificate of title, stability of the applicant’s job, proper valuation of the property, knowledge of the local, regional and international economic conditions as well as other market related factors. Each mortgage contract will require different remedies based on the red flags or threats identified during the assessment of the loan application information submitted by the customer.
Customers must also assess their own affordability situation. It is always advisable to work with a loan that can be serviced comfortably. Borrowers must avoid over extending themselves with little room to play in times of crises. Remember, no more than 30 per cent of your income should be committed to providing a shelter over your head. It is also important to cater for rainy days. Other cost related to property tax, property insurance, life insurance, health insurance, children’s education and other basic needs must also be taken into consideration when contracting a loan.
It is accepted that a country’s economic fortune can change over time. Individual financial circumstances will also change. The country might be hit hard by some form of natural or man- made disasters, one can lose a job or fall ill. The idea is to be prepared at all times to deal with your personal circumstances and avoid being over extended and cannot service your debt.
This article was submitted by Dennis S. M. Cornwall, Manager, Research and Marketing, ECHMB as part of the activities commemorating Financial Information Month, October 2013, celebrated under the theme “Reshaping Our Future – Starting Now”. The views expressed in this Article are those of the author and not necessarily those of the Eastern Caribbean Home Mortgage Bank.
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