Why must a borrower make equity contribution?

Because of the challenges in the housing market, banks have become lending shy to real estate developers and investors alike. Where a developer is lucky to find a willing lender, it is not only that the interest rate is unjustifiably high, the borrower is also required to produce off-takers for the intended development.

The question concerned market watchers are asking is, ‘if the developer has off-takers for his project, should he be looking for loans in the first place, when he can collect from the off-takers?’

This is exactly the question frequently asked, especially by those seeking loans from mortgage banks to buy, build or renovate their houses. If somebody is looking for N6 million to borrow to start a building project and he has N2 million which is about 30 percent of that loan amount, should he be looking for that loan? He could, of course, start off with what he has.

Strictly speaking, if somebody needs N6 million to start a building project and he has N2 million kept somewhere, if the lending institution asks him for 30 percent as his equity contribution for the loan, isn’t it rational or make economic sense for him to go back home and start his project with his N2 million?

But the mortgage market is structured in such a way that even when high interest rate, which is a big challenge, is removed from mortgage business, borrowers will still have some hurdles to cross and one of such hurdles is equity contribution usually demanded by mortgage institutions before they can advance loans to borrowers.

To the man on the street, the idea of equity contribution does not square up. He does not understand why somebody that is looking for money to borrow is required to bring money in order to get that money. The question he frequently asks is ‘why borrow if I had money to give?’

But the lender, the person who gives out the money, thinks differently and so has an answer to give to the question.

Mortgage loans are generally demanded and given for buying, building or renovating houses and when borrowers demand for this loan, they are required to bring about 30 percent of the loan amount they want as their equity contribution.

The street man wonders why somebody who wants to borrow N10 million, for instance, is required by the lender to bring upwards of N3 million in order to access the N10 million. His argument is that if he had such money, he probably would not have gone for the loan in the first place.

Mortgage banking operators, however, say there are reasons they demand equity contribution one of which is called “a hedge against loan repayment default”. Equity contribution, they explain, is fundamental to mortgage lending just as regular flow of income is.

Equity contribution is fundamental because there are institutional and regulatory developments that are still being expected in the industry. There isno a sound data-base of Nigerians yet; the national ID Card remains largely unreliable and foreclosure laws are still not strong.

All these issues, according to mortgage operators, have compelled mortgage banks to demand for equity contribution and they say that if they had all the above issues resolved, they would give people mortgage based on their credit rating.

Because mortgage banks do financial intermediation, it is their responsibility to protect depositors’ money and for them to protect those deposits, they have to ask for something that would act as a back-up to the money they give out to borrowers.

“If we had development funds, the kind of funds that we have in the manufacturing some sectors of the economy, where government gave out intervention fund over a period of 15 years at a single digit interest rate; if we had that kind of fund in the mortgage banking industry, it would be very helpful in a number of ways”, says a mortgage bank CEO who does not want to be mentioned.

Another mortgage banker who also pleaded anonymity, noted that “the banker and the borrower are in the same market in which case both suffer a common problem; we should not forget that we are all trading in one commodity which is money, and the trading is done in such a way that you sell according to how you buy”.

Another argument is that the credit the banks, including the mortgage institutions, have are short term in nature. So, they can’t lend long term and they do business in an environment that is very costly.

My advice, in all of this, is that the federal government, through the CBN, should do something about high interest rate charged by both the commercial and mortgage banks if the housing demand-supply gap is to be bridged.

Elsewhere, there are special interest rates on loans to real estate. Nigeria can do the same and the relevant authorities should look critically into the whole issue of equity contribution demanded from home loan seekers, especially the low income earners who cannot afford such loans.

Equity contribution is reason for the huge housing deficit and low home ownership level in Nigeria today. It could, perhaps, be reason too for the low performance of the Federal Mortgage Bank of Nigeria (FMBN) which administers the National Housing Fund (NHF) and is responsible for the disbursement of mortgage loans from contributors to the NHF.

Chuka Uroko