Understanding Home Loan Basics

Basic Terminology:

Home Loan is a type of loan offered to individuals who wish to purchase or construct a house. The property is mortgaged to the lender as a security till the repayment of the loan. The bank or financial institution will hold the title or deed to the property till the loan has been paid back with the interest due for it.

Terms associated with Home Loan:

  1. What is Down payment or Margin?

As Property prices are high, home buyers typically have to pay a certain percentage of the total value of a home. The remaining price is covered by a bank or financial institution through a mortgage or home loan. The amount that a home buyer pays is called as down payment or Margin. For example if you plan to purchase a property worth 80 lakhs, and the bank can fund up to 80% of total amount, which is 64 lakhs. You will have to pay remaining 16 lakhs.

In Jul 2010, RBI set a ceiling limit on home loans to 80% of the property value. But in case of small value housing loans of up to Rs 20 lakhs, home loan lending institutions can provide loans up to 90% of the property value, as such loans are part of priority sector advances. The higher the margin amount, lesser will be the loan amount, reducing the total cost of your property (since interest paid on home loan adds on to total cost of property).

  1. What is “Loan to Value Ratio”?

LTV (Loan to Value) ratio is the loan amount divided by the agreement value of the property for example, if the value of the property is Rs 40,00,000 and the lender is giving you a loan of Rs 28,00,000, the LTV is 70%.

  1. What is an Offer/Sanction Letter?

An offer letter is a formal confirmation from the bank stating that it has agreed to consider the prospect as one of its loan customers. It does not confirm sanction of home loan. The loan will be disbursed after a verification of all legal documents and eligibility of applicant. The validity of a sanction letter is generally around 6 months. If the loan is not availed during this period, the sanction lapses and the entire process needs to be reworked if applicant approaches bank again.

A sanction letter usually states the following;

  1. Amount of loan sanctioned
  2. Loan tenure
  3. Interest rate applicable
  4. EMI and pre-EMI amounts applicable
  5. Validity of sanction letter
  6. Terms and conditions of loan agreement

    What is Disbursement and different ways of disbursement?

Disbursement means payment. It refers to the release of loan amount to the borrower by the lender. Usually, banks disburse the loan amount once all the submitted documents have been verified and the down payments have been paid. A loan is always disbursed by cheque which can be credited into a loan account with the bank; it is never given in cash.

Most banks charge a loan disbursement fee. It is added to the principal amount when the loan is granted. This fee covers all expenses involved in disbursing the loan.

A loan can be disbursed in different ways, depending on the client’s arrangement with the bank and its policies:

Full disbursement: A full disbursement means the entire amount is paid in one go. The bank hands over entire payment to seller on your behalf.

Partial disbursement: A partial disbursement means that the payment is made in stages. If the client is buying an under construction property, then the bank will disburse payments as the construction progresses. For example, after completion of first floor, 20% of the payment will be made and so on.

Advance Disbursement: An advanced disbursement means that the entire payment is made before the completion of project. This is done only if the buyer requests the bank to do so, or is convinced that builder will complete construction on time.

5.What are Equated Monthly Installments (EMIs)?

EMI is the repayment which the client makes to the lender every month. It is an unequal combination of the principal repayment and interest payments. According to the thumb rule, EMI should not exceed more than 30% of the client’s total income, considering other liabilities. To arrive at EMI, the bank will consider several parameters;

  1. Principal amount
  2. Repayment period
  3. Rate of interest

EMI payments start once the loan has been fully disbursed. A break up of the EMIs over the entire loan term can be found in the client’s amortization schedule. It’s important to go over the amortization schedule regularly to keep a track of any changes in interest rate or loan tenure made by the bank.

6.What is Pre-EMI?

When buying a property which is under construction, loan amount is partially disbursed to the builder. When a loan is partially disbursed, only interest payments are made on that amount. These interest payments are known as pre-EMI. So the longer time builder takes to complete construction, the more interest the client will pay to the bank, adding on to the cost of the property.

Pre-EMIs too have tax benefits. After the construction is completed, you can claim tax deduction in five equal annual installments. However, any principal repayments made during this period are not liable for tax deductions. But this should not stop you from making repayments as it brings down your loan burden considerably.

7.Is paying full EMI a better option than pre-EMI?

Even though paying pre-EMI seems more lucrative in the short run, as the client has to pay only the interest component, opting for full EMI payment is more beneficial in the long run. This way the client starts repaying principal amount even before getting the possession, reducing total cost by reducing the tenure of home loan.

8.What is Resale Property?

When a person purchases a property from someone who already owns it beforehand, it is termed as resale. It indicates that the client is not buying a new home straight from the builder and is not the first owner of that property. While buying resale property, make sure to have a record of all previous owners of the property and that the reseller has undisputed ownership of the property. This will ensure smooth processing of loan application.

9.What is meant by Pre-approved property?

A pre-approved property means that the concerned financial institution has verified all legal and technical documents of the project and has found them to be in order. So any buyer, who applies for a home loan for this property, need not get the legal verification done again.

[dm3_accordion] [dm3_collapse label=”There are several misconceptions held by borrowers related to pre-approved properties, here are a few of them:” state=”closed”]Getting a home loan is assured: Several builders misguide customers by assuring them home loans from the financial institution which has pre-approved their project. This is not true. Each application is assessed individually and there is no guarantee that home loan on pre-approved project will always get approved. The project will complete on time: Though the financial institution takes into consideration the builder’s past records and ability to complete projects on time, it doesn’t mean that it will take any action if construction is delayed. The project is legally safe: Though in most cases this holds true, sometimes, small banks undermine several legal aspects and approve the project to get more business. So it’s always advisable to check which bank has pre-approved the project. A reputed bank is less likely to undermine such details while giving approval. Less documentation is good: Since the project has been pre-approved, the builder can directly share several documents with the bank, keeping the prospective buyer out of the loop. This way the buyer is saved from the hassle of handling so many documents, but the buyer might never get access to important documents related to the project. The client cannot take home loan from other lenders: This is not true! Just because the project has been pre-approved by a particular bank, it doesn’t mean the client has to take the loan from them. The builder may try his best to convince you otherwise, but the buyer is free to take a home loan from any lender of his/her choice. [/dm3_collapse] [/dm3_accordion]

10.What is Credit appraisal?

Credit appraisal is a check on the applicant’s financial situation to determine eligibility for home loan and the maximum loan amount. Credit worthiness of an applicant assures his repayment capacity. Several parameters are considered to confirm the credit worthiness of a loan applicant;

  1. Incomes of the applicant and co-applicant
  2. Age of applicants
  3. Qualifications
  4. Nature of profession
  5. Employer
  6. Security of tenure
  7. Tax history
  8. Assets owned and investments
  9. Additional sources of income
  10. Recurring liabilities11. How is Pre-Payment of loan beneficial?

When a borrower chooses to make lump sum repayment of loan, it is termed as pre-payment. Pre-payments are beneficial as they help get rid of debt faster by reducing loan tenure.

12. What is Security in a loan?

Security is the asset provided by the borrower while taking a loan. In this case, the property being purchased serves as a collateral asset for the home loan. If the buyer fails to repay the loan due to certain circumstances, the bank can sell this property or convert it into an asset to recover the loan amount. Therefore, before finalizing a loan, one must analyze the terms and conditions of various banks, and choose the one with favorable terms.

13.Processing & Administrative Fees

Every bank charges processing and administrative fees for processing the documentation of home loans. On an average, the fee ranges from 0.5% to 2% of the loan amount.  Though it seems like a small percentage, it can add considerable weight to the client’s home loan costs. Several banks offer schemes wherein they waive off the processing fee, to attract more customers. So while choosing a bank, it is advisable to opt for one which offers the lowest or no processing and administrative fees.