The enactment of Saudi Arabia's long-awaited mortgage law will act as a catalyst for the domestic real estate sector. The law should enhance the market's sophistication and widen funding options for middle and low-middle income groups if applied and enforced.
The law's approval had been prioritized and believed to be at its final stages in the Bureau of Experts at the Council of Ministers.
Until now, someone hoping to buy a home would either dip into family savings or get a bank loan-options reserved for those who could afford substantial down payments, repayment schemes of 15 years or less, and high interest charges.
Mortgage recipients thus fell into a relatively low-risk profile for banks.
A mortgage law could change the entire equation, but it would do so at the expense of some social protections, which safeguard tenants against eviction from their homes.
The law could challenge this norm by allowing banks to repossess properties and evict owners who default on loan repayment.
Globally, foreclosure rules enable banks to demand repayment if a homebuyer fails to pay instalments.
In the event of a default, a judge appoints an agent to sell the property in a public auction to pay off the mortgage.
This practice is often regarded as inconsistent with the values of Islamic law, so it will be crucial to monitor how the law handles this issue.
Mortgage finance regulations have nonetheless, been applied successfully in other predominately Muslim countries such as Egypt and Malaysia.
The draft Saudi law contains five components, including regulations on mortgage registration, enforcement, financial leasing companies, real estate financing companies and general finance companies.
It is crucial that the law set up a central body to register title deeds, replacing the current system of having notaries public record deeds in a less-standardized way.
Under Islamic mortgages, banks buy the property on behalf of the borrower and re-sell it to them at a profit, allowing the buyer to pay them back in instalments.
Another "lease to purchase" method involves the mortgagee renting the property from the bank, while paying down the principal and gaining equity.
The absence of a clear mortgage law framework to govern property ownership, property repossession, enforced eviction and asset liquidation in the case of delinquency has deterred banks from expanding lending in this segment.
If protections for banks are adequate, they will in the long run be willing to increase the risk profile for borrowers, which could create greater loan opportunities for lower-income Saudi nationals.
With a mortgage law in place, borrowers would also eventually be able to secure loans at lower costs because of the legal backing involved in mortgage financing.
It will take time before the benefits of the mortgage law will be fully felt as banks will need to test the legal system's ability to enforce evictions. Banks, meanwhile, would slowly need to restructure mortgage-financing schemes to eliminate charging interest on the principal amount recurrently throughout the loan's duration rather than on the reduced amount.
The law's passage coincides with a period of continued risk-aversion among Saudi banks in the aftermath of the global financial crisis. Many banks have nonetheless cited retail banking as a key growth segment, and once mortgage-financing rules are entrenched, banks will lend more.
But they will be cautious not to support the creation of a sub-prime market comprising individuals barely able to keep up with instalments, particularly if interest rates begin rising as is likely to happen sometime in at the end of next year.
To curb lending risks, banks should apply reasonable income caps such that any borrower cannot take a mortgage of more than one third to 40 percent of their total income.
The law should also maintain a "safety ratio" of around 50 percent of gross income to prevent lenders from over-extending themselves.
Mortgage standardization would further improve efficiency and reduce transaction costs of home loan providers.
Banks could carry out due diligence on master developments only once, enabling them to concentrate on assessing the credit quality of individual borrowers.
While it is hoped the law's passage will allow much wider access to property ownership, such a reality could take time.
Egypt passed a mortgage finance law in 2001 and, a decade later, the sector is still in its infancy.
A key hurdle has been the discrepancy between the high cost of financing and the low incomes of the largest pool of possible home buyers. Saudi Arabia's challenge will be to expand the base of beneficiaries from the system.
Apart from banks, the mortgage law is poised to pave the way for independent home financers, such as Real Estate Finance Co. (REFCO), partly owned by the Saudi Public Investment Fund, which plans to offer mortgages once the law is in place.
In my next column, I will address the primary challenges that have been discussed in this article.
© Arab News 2012
