Mortgages play a critical role. Aside from supporting housing affordability and enabling the performance of housing markets, they facilitate leveraged asset ownership, offering a pathway to wealth building for those who have limited capital.

Previous analysis prepared for the Centre for Affordable Housing Finance in Africa (CAHF) demonstrated that arrears on mortgages granted to lower income borrowers were higher than mortgages in the conventional segment of the market. However, CAHF wanted to establish whether this performance was adequately priced into the product, and whether the profitability of mortgages granted to lower income borrowers was aligned with profitability in other segments of the market. After all, lender behaviour is a function of expected profits – if lenders can price for risk, higher defaults need not necessarily make mortgages unattractive for lenders.

To explore this question, the team at 71point4 was commissioned to build a model of mortgage loan performance, and to identify and quantify the key drivers of mortgage profitability.

The team used historic loan level data on mortgage performance to inform projections of payment patterns for a range of segments across the market. This was combined with estimates of costs to originate mortgage loans as well as the cost of capital in a discounted cash flow model. A Monte Carlo simulation was used to aggregate model points to generate a best estimate of the value of a mortgage at the point of origination for various segments of the market.

Outputs of the model and sensitivities were presented to a broad audience including lenders, other financial sector participants, Treasury and Human Settlements.

The analysis highlights that mortgages granted in the so-called affordable segment of the market are as profitable, if not more profitable on a risk adjusted basis, than mortgages granted in the conventional segment of the market. Lower profitability therefore does not explain limited mortgage lending to lower income borrowers. A number of other factors appear to limit mortgage lending. This includes borrower characteristics, including limited headroom and poor credit records as well as seller preferences; delays and uncertainty associated with obtaining a mortgage predispose sellers to cash. Administrative and governance related problems are also common in lower income areas. This includes title deed problems, poor compliance with building regulations and in some cases an inability to foreclose.

The findings of this analysis were instrumental in motivating the development of the Transaction Support Centre (TSC). Read more about the TSC here.