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know these before taking a home loan

Last updated: May 3 2007
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  • know these before taking a home loan

    YOU are looking for a home loan to fund your new apartment and see a special "festival offer" advertisement in the newspaper. Before rushing to call the home finance company and signing on the dotted line get more details, as there could be strings attached to the interest rates advertised. Here are ten questions you should ask your loan counsellor before deciding to take a home loan:

    Is it a fixed or a floating rate loan?

    Most home loan companies today offer floating rate loans as the default option. That is, it is assumed that the interest rate on your loan will move up or down with each revision in the benchmark rate of the home finance company. This can have serious implications for your repayment obligations over a 10/15-year period. Every percentage point increase in the interest rate could see your loan balloon by a few lakh rupees. If you need a fixed rate loan, you need to specifically ask for it when applying. The interest rate charged on a fixed rate loan may be 0.5-1 percentage points higher than that on a floating rate loan.

    What is the floating rate pegged to?

    Floating rates are usually determined with reference to a lending rate, determined by the home finance company. Your interest rate will usually carry a constant "spread" to this Prime Lending Rate (PLR), fixed at the time of taking the loan.

    If your home loan is at a spread of 0.5 per cent to the PLR, which is 8 per cent, you will pay an interest rate of 8.5 per cent per annum. So do check the reference rate for your home loan, and whether you are getting the best possible spread. Doing this after you have started repayments will cost you, as banks usually charge a fee of 0.5-1 per cent (of the outstanding loan) to negotiate a better spread.

    How often is the peg changed?

    Do check if the home finance company periodically revises the PLR to which your home loan interest rate is pegged. Do not assume that the lending rates will be automatically adjusted to the market rate. If the revisions are ad hoc or at the home finance company's discretion, you could remain locked into an uncompetitive rate when interest rates soften.

    Is the rate fixed for the entire tenure of the loan?

    If you have opted for a fixed rate loan, ask if the loan carries a "reset" clause. This means that the company reserves the right to revise the interest rates, upward or down, once in three or five years, even on your fixed rate loan. If your loan has a reset clause, you could find yourself paying a much higher rate of interest three or five years down the line, should interest rates spike sharply in the intervening period. Some home loan companies, such as ICICI Bank and HDFC, do offer products, where the rates remain the same for the entire tenure of the loan.

    Do I have a switch option?

    It may be quite difficult to decide between a fixed and a floating rate loan (or combinations of the two) at the time of taking the loan. Interest rates may be drifting down when you take the loan, but could begin to edge up after you begin repayments. So do check if the home finance company will permit you to move from the fixed to a floating rate loan or vice versa, during the tenure of the loan. Many institutions do not allow a switch from a floating rate to fixed rate loan. A few permit the switch, but only on payment of a switch fee amounting to 1.5-2 per cent of the loan amount.

    Are there restrictions on pre-payment?

    If your pay rises sharply after you have taken the loan, you may like to repay your loan much earlier than you originally planned. But not all lenders welcome such pre-payment. Some may restrict the number of pre-payments you can make during the tenure of the loan. Others may place an embargo on pre-payment in the initial years. Yet others allow you to pre-pay only a certain proportion of the loan each year.

    Is there a pre-payment penalty?

    Lenders may also levy a pre-payment penalty, at a fixed percentage of the outstanding loan amount, in case you decide to repay your loan ahead of schedule. A few home loan companies waive the pre-payment penalty when you repay the loan from your own funds. Others levy a 1.5-2 per cent charge irrespective of your source of funds.

    Is there a takeover charge?

    Even home loan companies which do not usually charge a pre-payment penalty are likely to demand a takeover fee, in case you switch your loan to a competitor. When a new lending institution issues a cheque to settle your claims with your present lender, the takeover fee will be charged on the outstanding loan amount. Cheques issued in your own name or from your own bank account, are unlikely to attract a takeover fee.

    What are the other charges that come with the home loan?

    Apart from the interest rate offered on your home loan, check what other charges you will be required to pay to get the home loan. There could be a processing fee, a service fee and administrative charges.

    These could be levied as a flat fee or a fixed percentage of your loan amount, on sanction. Remember that the percentages are usually pegged to the loan amount sanctioned to you, rather than what you actually take.

    Once repayments start, you may have to pay separate charges for swapping your post-dated cheques, changing the size of your monthly instalment or tenure. Also check what the lender's policy is on pre-disbursement interest. You have to pay a pre-disbursement interest on any part of the loan drawn before you make the full payment to the builder.

    Can I read the loan agreement?

    Ask to the read the loan agreement before you sign it. This may seem difficult, as the loan agreement is usually a bulky document running into several pages. But this is important. No matter what you verbally agree with the lender's representative while negotiating the loan, it would not be legally binding unless it is validated in writing in the home loan document.

    In practice, home loan companies may ask you to sign a blank loan document while taking a home loan to speed up the processing. The details may be filled in later and sent back to you by post. But you can ask to read a draft agreement before you sign on the dotted line.

    Also be sure to check the details filled in your loan document as soon you receive the final version, to make sure that the terms are the same as you agreed.

    Finally, when in doubt, protest. If you find any revision in interest rates or changes in the terms of your loan, immediately get in touch with your home loan company to clarify the issue.

    Speaking up, in this case, may help you save thousands of rupees in loan repayments.
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