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What Should You Look Into While Availing A Home Loan? - Outside View by PersonalFN
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What Should You Look Into While Availing A Home Loan?
Apr 28, 2016

The one asset every Indian would like to own is a house. Most young individuals start off having a strong inclination to buy their own place. Some of us even buy a "second home" as a weekend gateway or as an investment. We take pride in owning a house and carefully design it with the best interiors.

Given the real estate prices these days and the amount that needs to be invested, buying a house is the biggest investment decision one can take. Though affordability is difficult at times, Home Loans can be a good instrument to help you purchase this asset.

However, ask any person how they would choose the financial institution to approach for this home loan and the only criteria that comes up for discussion is the one offering the cheapest rate! No doubt interest rates matter, but it shouldn't be the only criteria especially when a home loan is going to be the longest debt in our lives.

While purchasing a house, the home loan would be able to provide only 80% of the agreement value of the house, the balance 20% is allocated from one's savings, investments, etc. Moreover, when the EMIs run across 15 to 30 years, it may put a strain on not only your savings but your other financial goals as well. Make sure you have a well-constructed financial plan in place allocating the right resource for achieving the goal.

We list some of the checkpoints that you should consider before signing up with a financial institution:

How is eligibility decided? Home loan eligibility depends up on various factors. A few of them are listed below:

  • Suit filed or written off cases reported in the Credit Information Report (CIR). This is indicated in the 'Account Status' section of your CIR.
  • Payment history trend: If there has been any default or amount overdue. This is indicated in the 'Days Past Due' (DPD) field of your CIR.
  • Company profile where you work: The banks generally have an approved list to which they extend the loan.
  • Tenure of the loan: The longer tenure you opt for, the more is your home loan eligibility.
  • Interest rate offered: If your interest rates are on a lower side, then the loan eligibility will be higher and vice versa.
  • Existing loans: In case you have any existing loans, then the loan eligibility amount will come down to keep the EMI to income ratio around 0.50.
  • EMI to Income ratio: If your current total EMI exceeds your monthly salary by more than 50% then chances of getting loan are reduced. Let's take the help of an example to understand this further.
Determination of Eligibility
Sr. No Particulars Case Study 1 Case Study 2
a Income (Rs) 50,000 100,000
b Total EMIs being paid (Rs) 10,000 50,000
c EMI to Income Ratio (in percentage) (b/a) x 100 20 50
d Rule of thumb to Income ratio (lenders assume you will need half of your salary for living expenses) 50% 50%
e Total borrowing capacity (a x d) 25,000 50,000
f Total incremental EMI that an individual can afford (e - b) 15,000 -
g Total additional loan that may be sanctioned at an interest rate of 10% over 20 years (f/10%) x 100 15,000,000 -
(Source: www.cibil.com)

Credit Score: If you are a first time borrower, then you may not be aware of your credit score. Credit Information Bureau (India) Limited (CIBIL) collects and maintains credit records of individuals as well as commercial entities including borrowing and payments related to loans and credit cards.

A credit score is a three digit numeric summary of your entire credit history. It is prepared based on the information provided in your Credit Information Report. The credit score ranges from 300 to 900 (As per CIBIL, 79% of the loans approved are for individuals with a score greater than 750). Without a satisfactory credit score, you may not be eligible for many loans.

Your credit score can be affected because of:

    Payment history: Making late payments or defaulting your EMIs or dues (recently or consistently) shows you are having trouble to pay your existing credit obligations and will negatively affect your score.

    High utilisation of credit limit: While increased spending on your credit card will not necessarily affect your score in a negative manner, an increase in the current balance of your credit card indicates an increased repayment burden and may negatively affect your score.

    Higher percentage of credit cards or personal loans (also known as unsecured loan): Having a balanced mix between the secured loans (such as auto, home loan) and unsecured loan (such as personal loan, credit Card) is likely to have a more positive affect on your score.

    Many new accounts opened recently: If you have recently been sanctioned multiple loans and credit cards, then lenders will view your application with caution because this behaviour indicates your debt burden has increased, which will negatively impact your score.

After you fill and submit your loan application form, a bank will check your credit score and credit report. If you have a bad credit history and a low credit score, the bank may reject your loan application outright. Only if your credit score is good will a bank consider your loan application and pass it through for approval. If you have fallen into a debt trap because of which your score is suffering, then prioritize repaying your debt obligations first.

Which rate should you opt for - Fixed Rate v/s Floating Rate? Home Loan interest rates are dependent on the home loan amount, loan tenure, the profile of the borrower and his credit score.

A fixed rate is predetermined (fixed) for the entire tenure of the loan, while a floating rate is linked to the benchmark rate or the base rate of the financial institution. But these days most of these fixed interest rates come with a reset clause where the bank has an option to change the interest rate after a fixed period of time generally in a range of 3 to 5 years.

The floating home loan interest rate will change as and when the bank will change its benchmark rate or the base rate and are cheaper compared to the fixed rates.

Some lenders even offer hybrid home loan interest rates. In recent times, some lenders have come up with innovative home loan products like teaser / dual rate of interest, where the interest rate on such loans remains fixed for initial 1-5 years, and thereafter it automatically moves to a normal floating rate of interest.

Certain banks give the borrower a flexibility to convert from a fixed rate of interest to a floating rate and vice versa without paying any fee or penalty.

How much will be the down payment? Home loans in India are provided by the lenders up to a maximum of 80% (90% in certain cases) of the agreement value of the house. In case of home loan for resale flats, most lenders get the property valued independently, and they will provide the housing loan based on their value rather than the cost mentioned in the purchase agreement. Frequently, the valuation as determined by the banker's evaluator, for the purpose of home loan, is significantly lower than the actual market value, and hence the requirement of the borrowers for down payment for the loan goes up.

Also take into account that the banks do not consider other charges like Stamp Duty, Registration Charges, etc. while considering the home loan amount eligibility.

What about the processing fees? Most banks and housing finance institutions charge a processing fee to process your application for a home loan. Paying the processing fee is inevitable whether your loan is sanctioned or not and this isn't refundable. Generally, the processing fee varies from 0.5% to 1% of the total loan amount sanctioned or a fixed rate (whichever is higher). So before paying the processing fees, bargain on it and get a documented confirmation from the bank.

Are there any prepayment charges? Prepayment fees come into the picture in case one wants to either prepay his home loan or switch to a different lender. As per the guidelines issued by the National Housing Bank (NHB) and Reserve Bank of India (RBI), no penalty is to be charged on prepayment of a floating rate interest loan. However, the same benefit is not available for a borrower with a fixed rate of interest. It is a prudent practice to take down all the charges from the bank in writing and the written document should be preserved in case the bank asks you to pay a different amount after sometime.

A home loan is actually one of the best ways to build up your assets using a liability. You are effectively putting down some of your own money (the down payment), and garnering the rest (i.e. someone else is paying for it upfront, you are paying them back in instalments).

Remember to insure the loan and increase your contingency reserves to include enough liquid funds for a minimum of 3 EMIs that will be available for use in case of a financial emergency.

Dear reader, we hope this article has been informative and assuaged some of the fears/doubts regarding home loans, and made the process of acquiring one a little more transparent and easy to understand.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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