Home in on the right loan

Choosing the right loan scheme requires you to do a lot of homework. Here is an overview of some of the most important factors that must be taken into account....

Buying a house requires a large outlay of capital,but equally importantly,some serious thinking on the home loan borrowers part. Banks and housing finance companies (HFC) do help out borrowers by providing counselling. But mostly it is up to the borrower to do the research and acquire adequate knowledge before applying for a loan. There are lots of choices to be made: between lenders,different types of schemes,and so on. Only if the borrower has done his homework will he be able to make the right choices choices that will have an impact on his finances for the next 15-20 years.

When borrowers set out to take a home loan,the parameter that most of them give primacy to is the interest rate. However,along with interest rates,there are several other factors that they must take into consideration.

Fixed or floating

Fixed-floating loans. Two kinds of interest rates on housing finance are available in India: fixed rate and floating rate. A new kind of home loan that has caught on recently is the one where the interest rate remains unchanged for the first three to five years. In the case of this type of loan,even if interest rates drop in the market,the borrower does not get the benefit of the decline. Conversely,if interest rates go up,his equated monthly instalments (EMI) remain unchanged. Currently the interest rate on such fixed-floating type of loans is around 8-8.5 per cent for the initial period. After this period is over,the home loan borrower will have to pay the interest rate that is prevalent at that point of time on the floating-rate scheme. Given the low rates,opting for such a loan scheme is very much in the borrowers interest. However,the borrower must give serious consideration to whether he will be able to afford the higher EMIs that will come into effect once the initial grace period is over. If there is a chance that he could default,he should refrain from taking such a loan.

Story continues below this ad

Floating-rate loans. The interest rate on a floating-rate loan varies depending on where interest rates within the economy are headed. Currently the rate of interest on these loans varies from institution to institution and is broadly in the range of 9.5-12.5 per cent.

Home loan borrowers must,however,remember that the choice of fixed or floating need not be a once-in-a-lifetime choice. If one has selected a fixed-rate scheme and finds that the current market situation favours a floating rate of interest,or vice versa,one can always switch from fixed to floating,or in the opposite direction. Banks usually charge a fee of about 1.5-2 per cent of the principal outstanding for allowing such a switch.

Fixed-rate loans. A third kind of loan scheme that is available in the market is the fixed-rate loan. The interest rate on these loans is usually higher than on a floating-rate loan. Even here one must read the document carefully. There are fixed-rate schemes where the lender reserves the right to revise the loan rate every few years,and there are a few fixed-rate schemes where the loan rate remains truly fixed throughout the tenure of the loan. The latter are known as fixed-rate schemes without the market clause. If you are ready to pay the higher interest rate charged on a fixed-rate loan,then you must opt for the latter type of product.

Be wary of prepayment charges

Another important factor that needs to be considered while taking a home loan is the prepayment charge. Prepayment charge is applicable if you decide to repay the loan before the stipulated period. This charge again varies from one player to another and could range from 0.5-2 per cent of the principal outstanding. Lenders sole motive behind levying the prepayment charge is to discourage borrowers from prepaying the loan before the stipulated period as this results in loss of interest income for the bank. Most public sector banks dont levy a pre-payment penalty if you make the prepayment using your own funds and not through re-financing. No charges are levied for part-prepayment.

When should you refinance

Story continues below this ad

A borrower can opt for refinancing if the interest rate offered by another bank or HFC is much lower than his current rate. He should take into account the pre-payment penalty that he will have to pay on his existing loan and then see what savings will accrue to him from the switch.

Keeping this eventuality that one may have to go for refinancing some day in mind,always choose a bank or HFC whose prepayment charge is not too high.

Loan to value ratio

When you take a home loan,it is unlikely that the bank will offer you 100 per cent of the value of the property. Rather,it will offer you a loan for only a part of the value of the property. Currently,this loan to value or LTV is around 85 per cent,i.e.,you will have to pay 15 per cent of the value of the property out of your own pocket.

Affordability

Banks also calculate your loan affordability by restricting the maximum EMI to around 60 per cent of your net take home salary (minus EMIs on existing loans). For instance,suppose that Ravi has a net take home salary of Rs 50,000 per month,out of which he is paying an EMI of Rs 8,000 on his car loan. This will reduce his net take home salary to Rs 42,000. The EMI payable on his home loan cannot exceed 60 per cent of this amount. Thus banks will give him a loan only for an amount on which the EMI doesnt exceed Rs 25,800.

Story continues below this ad

A common problem for home buyers is the unaccounted cash component in the purchase of a house. No bank will fund this component,hence the effective LTV comes to much less than 85 per cent.

As must be clear by now,taking a home loan is not a simple matter. Learn about the subject,understand its intricacies,and then go for the best possible offer.