This article has been written by Parin Karania pursuing a Diploma in US Corporate Law for Company Secretaries and Chartered Accountants from LawSikho, and has been edited by Shashwat Kaushik.
It has been published by Rachit Garg.
Introduction
A home loan is a type of loan provided by a bank or financial institution to help you purchase your dream home. It is a long-term loan, usually with a tenure of 15-30 years, and is secured against the property you are purchasing. The loan amount, interest rate, and tenure of the loan are determined by your income, credit score, and the value of the property.
If you’re considering taking out a home loan, there are several things you should keep in mind. In this article, we’ll cover some of the key practical considerations while taking a home loan.
Key practical considerations while taking a home loan
Some key practical considerations while taking a home loan are:
Decide on your budget
Before you start looking for a home loan, it’s important to determine your budget. This will help you determine how much you can afford to borrow and what kind of home you can realistically afford. There are several factors to consider when determining your budget, including your income, expenses, and other financial obligations.
Shop around for a loan
Once you have determined your budget, it’s time to start shopping around for a home loan. There are many different lenders and loan plans available, so it’s important to do your research and compare your options. Some key factors to consider when comparing loans include the interest rate, fees, repayment terms, and any additional features or benefits.
Consider pre-approval
A pre-approval is a letter from a lender stating that you are eligible for a home loan up to a certain amount. A pre-approval can be a helpful tool when house hunting, as it can give you a better idea of what you can afford and help you narrow your search. To get pre-approval, you’ll need to provide the lender with your financial information, such as your income, expenses, and credit score. Normally, pre-approval is valid for 6 months only, so make your dream home decision accordingly.
Understand the loan terms
Before you sign on the dotted line, it’s important to understand the terms of your home loan. This includes the interest rate, repayment terms, fees, and any other conditions or requirements. Make sure you read and understand all the fine print before agreeing to the loan.
Plan for repayments
Once you have taken out a home loan, it’s important to plan for repayments. Ensure you understand how much you need to repay each month and plan your budget accordingly. It’s also a good idea to set up reminders to ensure you don’t miss any payments.
Consider extra payments
If you can make extra payments on your home loan, it’s worth considering. Making extra payments can help you pay off your loan faster and save on interest charges.
Features and benefits of home loans
- Fast loan processing: The home loan documentation requirement is very crisp. Also, the eligibility criteria are not very strict. This helps banks and financial institutions process loans faster.
- Low-interest rate: Home loan rates of interest are lower than other secured loans.
- Multi-purpose: Available for various purposes like buying a new residential flat or building, constructing a new house on a plot, doing home renovations, or extending your current house.
- Easy availability: All the banks and financial institutions are offering various housing loan schemes. You can avail yourself of a home loan after checking your eligibility and meeting your requirements.
- Tax benefits: You can claim a tax deduction of Rs. 1.5 lakhs on the principal repayment under Section 80C of the Income Tax Act of 1961 and Rs. 2 lakhs on the interest repayment under Section 24B of the said Act. You can also claim a home loan tax deduction when you pay for the registration fees and stamp duty charges under Section 80C.
- Long tenure: Since the loan amount involved in home loans is huge, the tenure of home loans goes up to 30 years, which makes EMI affordable and ensures that the monthly budget is not under any kind of pressure.
Eligibility criteria for a home loan
Age: Your age should be 23 years to 62 years upon maturity of the loan, and you must be an Indian citizen.
Income: Only stable income will be taken into account to check eligibility
Credit score: A credit score above 750 is considered good. But with a credit score of less than 750, you can also get a home loan, but the ROI will differ. Therefore, it is advisable to have some credit history; if you don’t have any credit history, then you might need to pay a higher ROI. To generate credit history, one can apply for a credit card and get a credit score of more than 750 by paying with the card before the due date.
Loan to value ratio: 80% to 95% of property value; it depends on a case-to-case basis.
Employment status: Salaried or non-salaried both are eligible, but document requirements and ROI will differ.
Key terms with respect to home loans
Some key terms with respect to home loans are explained below.
Approved Project Financing (APF)
The APF (Approved Project Financing) number is indeed provided by banks and financial institutions to authorised builders of a house, building, or project. This number signifies that the bank has evaluated and approved the project based on various parameters, such as legal, technical, and financial aspects. Having an APF number for a project streamlines the loan application process for home buyers as it simplifies the documentation requirements. However, it’s essential to note that just because a project has an APF number doesn’t guarantee loan approval; buyers must still meet the bank’s eligibility criteria. Home buyers should indeed check which banks or financial institutions have provided an APF number to their interested projects and apply for a loan with them. It’s also recommended to compare loan offers from different banks to choose the one that best suits their needs.
Floating rate of interest and fixed rate of interest
It’s true that most home buyers opt for floating interest rates when borrowing home loans, which are linked to the REPO rate. The advantage of floating interest rates is that they may be lower than fixed interest rates and may reduce the overall cost of the loan. Additionally, if the REPO rate decreases, the floating interest rate may also decrease, resulting in lower EMIs.
On the other hand, fixed interest rates remain constant throughout the tenure of the loan, which means that the borrower can predict their EMI and plan their repayments accordingly. However, fixed interest rates are generally higher than floating interest rates by around 1%, and banks may charge pre-payment penalties if the borrower wishes to pay off their loan early. Furthermore, converting from a fixed interest rate to a floating interest rate may also incur conversion charges.
Whether to opt for a floating or fixed interest rate depends on the borrower’s individual preferences and financial situation. If the borrower prefers certainty and predictability, a fixed interest rate may be a better option. However, if they’re comfortable with fluctuations and willing to take on some risk, a floating interest rate may be more cost-effective. Therefore, it’s not recommended to always select a floating or fixed interest rate without considering your financial situation and risk tolerance. It’s essential to weigh the pros and cons of both options and choose the one that best suits your needs.
Home loan insurance
A home loan insurance plan is a scheme under which the insurer will settle the outstanding home loan amount with the lender or bank in case of an unforeseen situation. Some of the comprehensive home loan insurance plans offer coverage for the applicant, the house, and all its contents. This insurance premium is added to the loan amount, and the EMI of the home loan increases accordingly. This insurance is not compulsory for borrowers, but bank officials suggest borrowers take it. The loan tenure and insurance coverage period must be the same. It is not advisable to opt for a shorter cover period, thinking that you will extend it later. There is a very strong chance that you might forget to extend in the long run. Also, as you grow older, it becomes more difficult for you to get good coverage. Even if you get one, it will be expensive.
Down payment
The amount of money that the borrower pays upfront when purchasing a home is typically expressed as a percentage of the purchase price.
Stamp duty and registration fees
Usually, home buyers don’t consider the cost of stamp duty and registration fees when purchasing a home. Normally, it is around 8% of the value of the property. While planning the home purchase, consider the cost of stamp duty and registration fees.
Refinancing the down payment
If the borrower had made a larger down payment to the builder or seller of the home, If the loan agreement permits, the borrower who made the additional payment will receive a portion of the loan amount. The borrower may be able to receive a portion of the loan amount in their savings account. This would typically depend on the terms of the loan agreement and the policies of the lender. The borrower should check with their lender regarding the possibility of a part-disbursement of the loan amount to their savings account.
ROI – differs with size of loan
If the loan size is not more than Rs. 30 lakh, some banks charge a lower ROI by 10 to 20 basis points compared to higher loan amounts. So, if you are taking a loan of Rs 31 lakh, then reduce your loan to Rs 30 lakh and avail yourself of such benefits. If your loan size is very large and you have sufficient income support, then you can have healthy bargaining power, and the bank will provide you with a loan at the lowest ROI as per their norms.
Margin percentage – differs with size of loan
Normally, banks approve and sanction 80% of the value of property; the remaining 20% needs to be paid by the borrower. This 20% is called the Margin Percentage. Some banks keep only a 10% margin if the loan size is less than Rs 30 lakh. So small buyers will get a higher loan amount, which is very helpful for them. It’s important to note that the margin percentage may vary depending on the lender, the borrower’s creditworthiness, and the type of loan. Borrowers should carefully evaluate their financial situation and choose a margin percentage that they can comfortably afford.
Margin percentage – differs based on category of builder
Big builders like Lodha, L&T, etc. are termed a category builder by banks. If you are purchasing a home from such builders, Banks will fund your home loan by 95% of the value of the property, and only a 5% margin will need to be paid by you. Normally, big builders have agreements with private banks, and accordingly, such private banks will keep less margin money than 5%. It’s important to note that the specific loan terms may vary depending on the lender, the borrower’s creditworthiness, and the type of loan. Borrowers should carefully evaluate their financial situation and choose a loan amount and down payment that they can comfortably afford.
Different banks – different rates of interest (ROI)
Every bank will charge an ROI on a home loan. Public and private bank ROI is lower than cooperative bank ROI, while NBFC ROI is much higher than the banks. When the REPO rate is declining, the ROI of public and private banks will also decline as ROI is linked with REPO. To reduce the ROI, the borrower will have to file one application with fees normally below Rs.1000/-. But co-operative bank ROI is not linked with REPO. Therefore, they will not reduce their ROI when REPO is reduced, and similarly, they will not increase ROI when REPO increases. Therefore, when REPO is increasing ROI, the Co-operative bank will be lower than the government and private banks for one or one and a half years; afterwards, co-operative will increase ROI, and then it will be higher than the government and private banks. To reduce the ROI when the REPO rate reduces, the borrower will have to file one application with fees normally below Rs.1000/- and some banks don’t charge any fees.
Conclusion
A home loan can be a practical way to achieve the dream of homeownership. Taking out a home loan is a major financial decision that requires careful consideration and planning. By understanding the basics and some advanced terms and scenarios of home loans and considering factors such as your credit score, down payment, income and expenses, loan term, ROI, fees, APF, etc., you can make an informed decision and find a loan that works for you.
References
- https://www.bankbazaar.com/home-loan-interest-rate.html
- https://www.pnbindia.in/interst-rate-on-advances-linked-to-mclr.html
- https://www.unionbankofindia.co.in/english/apply-online-home-loan.aspx
- https://icmai.in/upload/Students/Download_Archives/paper12.pdf
- https://www.ltfs.com/blog/an-essential-guide-to-housing-loan#:~:text=Eligibility%20for%20a%20Housing%20Loan&text=The%20loan%20amount%20you%20are,you%20are%20a%20reliable%20borrower.
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