Mortgages and real-estate finance

A mortgage is a loan secured by the property it bought. If the borrower stops paying, the lender takes the property and sells it to recover the loan. That single mechanism — collateral — is what allows banks to lend at lower rates against real estate than against unsecured borrowing, and it's the foundation that the entire residential property market sits on. Understanding mortgages mechanically is non-optional for real-estate analysis: the financing layer dominates the equity returns in module 3, and mortgage market structure determines the price level for residential property in module 11.

The amortisation formula, derived

A standard fully-amortising mortgage pays the same amount every month for the loan term. Some of that payment is interest on the outstanding balance; the rest is principal. Over time, the outstanding balance shrinks, the interest portion of each payment shrinks with it, and the principal portion grows. By the final payment, the loan is fully repaid.

The monthly payment is the value M that makes the present value of n equal payments at monthly interest rate r equal to the original loan principal P:

  P  =  M  ×  ( 1 − (1 + r)^−n )  ÷  r

Solving for M:

  M  =  P  ×  r  ÷  ( 1 − (1 + r)^−n )

Variable glossary

• M — monthly payment, in currency. The fixed amount the borrower pays each month, comprising interest and principal in changing proportions.
• P — loan principal at origination, in currency. The amount actually borrowed. For a KES 10m apartment financed at 70% LTV, P = KES 7m.
• r — periodic interest rate as a decimal. Critical: this is the PERIODIC rate, not the annual rate. For a 13% annual rate compounded monthly, r = 0.13 / 12 ≈ 0.01083. Using the annual rate directly in the formula gives a wildly wrong answer.
• n — total number of payments. For a 20-year mortgage paid monthly, n = 20 × 12 = 240.

Worked example: a Kenyan apartment mortgage

Borrower: KES 7m principal, 20 years, 13% annual, monthly payments.

  r  =  0.13 / 12   =  0.010833
  n  =  20 × 12     =  240

  M  =  7,000,000  ×  0.010833  ÷  ( 1 − (1.010833)^−240 )
     =  7,000,000  ×  0.010833  ÷  ( 1 − 0.0758 )
     =  7,000,000  ×  0.010833  ÷  0.9242
     ≈  KES 82,025  per month

Total of all payments  =  82,025  ×  240  ≈  KES 19.7m
Total interest paid    =  19.7m − 7m       ≈  KES 12.7m

Reading the amortisation schedule

An amortisation schedule lists every payment by month: the opening balance, the interest portion (= opening balance × monthly rate), the principal portion (= total payment − interest portion), and the closing balance (= opening balance − principal portion). Month 1 of the example loan: opening balance KES 7,000,000; interest = 7,000,000 × 0.010833 = 75,833; principal = 82,025 − 75,833 = 6,192; closing balance 6,993,808. Month 1 was 92% interest, 8% principal. Month 120 (the 10-year mark) of this loan is roughly 60% interest / 40% principal. Month 240 (the last payment) is roughly 1% interest, 99% principal.

Three mortgage structures

• Fixed-rate, fully amortising. The mortgage rate is fixed for the entire term. Monthly payment is constant. Interest-rate risk sits with the LENDER (if rates fall, the borrower can refinance; if rates rise, the lender has locked in a lower yield). The US standard. Rare in Kenya because Kenyan banks fund themselves at short tenors and can't economically write a 20-year fixed-rate loan.
• Variable-rate (floating). The mortgage rate resets periodically against a benchmark — typically the Central Bank Rate (CBR) plus a margin in Kenya, or SOFR plus a margin in the US. Monthly payment changes with rates. Interest-rate risk sits with the BORROWER. The Kenyan and African standard.
• Hybrid (e.g. 5/1 ARM). Fixed for an initial period (e.g. 5 years), then floats. Common in the US for borrowers who plan to sell or refinance within the initial fixed period.

Prepayment and refinancing

Most mortgages allow the borrower to prepay — pay off the loan before maturity, in part or in full — but some have prepayment penalties. A borrower with a 13% mortgage will refinance into a 10% mortgage if rates fall, because the present-value savings exceed the closing costs. The lender therefore faces 'prepayment risk' on a fixed-rate mortgage — they own a bond that gets called when it's most valuable. This is one of the reasons fixed-rate mortgages carry a rate premium over variable-rate ones.

The Kenyan mortgage market — why it's tiny

Kenya's outstanding mortgage book in 2024 is approximately KES 250–300 billion across roughly 30,000 active mortgages. As a share of GDP that is about 1.5%. Comparable figures: South Africa ~25% of GDP, the UK ~70%, the US ~60%. Five structural reasons:

• Bank funding tenor mismatch. Banks fund themselves with short-term deposits and can't comfortably write 20–25 year fixed-rate paper. Variable-rate works but the rate risk on the borrower compresses demand.
• Title and collateral friction. Foreclosure in Kenya takes 18–36 months, costs significantly, and the social/political cost of evicting can be high. Banks therefore underwrite conservatively (low LTVs, high DSCR cushions, premium pricing on top of the base rate).
• Borrower income documentation. A large share of Kenyan household income is informal, irregular, or undocumented in ways that match bank-credit-scoring models. The pool of formally-employed PAYE-paying borrowers banks will lend to is small.
• Affordability. At the average Kenyan two-bedroom apartment price of KES 6-10m, a 70% LTV mortgage at 13% over 20 years implies a monthly payment of KES 70-115k. The household earning that level of disposable income to service it is in the top decile.
• Interest-rate level. Kenyan mortgage rates of 12-15% are 5-7 points above the equivalent UK / US rate; the resulting payment is much larger relative to the loan principal.

What KMRC is trying to do

The Kenya Mortgage Refinance Company, established 2018, is a single-tier secondary-market lender. KMRC borrows long-term in shilling or in concessional foreign currency (World Bank, AfDB) and on-lends to primary mortgage lenders (banks, building societies) at fixed long-term rates. The primary lender can then offer a mortgage at the KMRC rate plus a small margin — typically 9.5–10% all-in versus the 13–15% off-balance-sheet rate. As of late 2024 KMRC has refinanced roughly KES 8–10 billion of mortgages across 7,000+ borrowers — small but accelerating. The economic argument: solve the bank funding-tenor mismatch with a single national-scale aggregator, and the rest of the market follows.