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Home Loans: Revisiting the basics


Home Loans: Revisiting the basics

Last updated: August 18 2012
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  • Home Loans: Revisiting the basics

    It is that time of the year when most prospective home owners settle on a property of their choice and start the process of actual purchase. Here are a few tips to make the most significant investment of a lifetime, hassle free.
    Reduce liability with higher down payment: The Reserve Bank of India recently brought in a new ruling effective from February, this year to curb property values being inflated.

    Accordingly stamp duty, registration and other taxes like VAT and service tax will be excluded when property value is considered for determining the loan amount. This means home loan borrowers need to pay these charges as part of their down payment. This news should not be taken negatively by the borrower. It is actually a blessing in disguise.

    Why? The more the down payment, the lesser the loan amount and consequently, lesser the interest cost.

    In fact, borrowers should strive to increase the down payment as much as they can afford, to save on both the interest cost and the time to repay the loan, helping them become the owner of the house without having to wait it out for 20 or more years.

    Time your purchase well: It is a good idea to choose a time when builders try and promote the sale of property with attractive discounts. This typically happens during the period before interest rates begin the downward trend, when builders like to quickly sell out slow moving projects that had accumulated during a high interest regime.

    In fact the time now is ideal as the exact scenario described above is unfolding now, with interest rates expected to decline anytime in the next few months.

    Borrow when interest rates begin downward trend: You should try and take a home loan when interest rates begin the downward trend to cash in on the falling rates, which will help you lower the interest cost of your loan.

    Decrease tenure through partial prepayments: You can use part of your savings to prepay the loan thus reducing the tenure. If your loan amount is well within 40 per cent of your income, you could easily set aside money to prepay at regular intervals.

    From your savings try and set aside 10- 20 per cent of your income for home loan repayment.

    Accumulate this amount every three months and make a quarterly prepayment.

    With most housing finance companies and some banks having done away with pre payment charges, this is a good incentive to prepay. Even if there are pre-payment charges, please note most banks do not charge a penalty for partial prepayments up to a certain limit.

    Verify these details before you plan your loan prepayment and make the most of the specifications for prepayment.

    Moving to a better space while repaying the current loan: Typically a home loan has a very long tenure and the cycle is filled with highs and lows in interest rates, which can easily stretch the loan to several years unless you actively follow some the steps detailed above to repay your debt quickly.

    After the first five or six years of your home loan, you might want to shift to a bigger house or a better location as your needs dictate.

    In such an instance, you can, after a discussion with your bank, sell your existing home for a good profit, and repay the remainder of your loan.

    You can then shift to a bigger home with a new home loan and a higher down payment.

    On an average, in this case, it is best to restrict your loan tenure to 10 years if you opt for a 20 year loan.

    Factor in your career prospects, increase in passive income, spouse’s income, accumulated savings etc. and optimise the benefits from these factors to close out your debt.

    Home Loans: Revisiting the basics
    Please read IREF rules | FAQ's
  • #2


    Re : Home Loans: Revisiting the basics

    Dear friends,

    My home loan has been partly disbursed 2 months back from SBI. The loan includes a moratorium period of 18 months. For the last two months only the simple interest was getting calculated and accrued to my loan account. however, this month, the bank has by mistake started taking the full EMI from my savings account and crediting it to my loan account through ECS. This ECS payment of full EMI was supposed to have started after 18 months.

    When I contacted the bank, the branch manager told me that this full EMI has been incorrectly scheduled but if I have the capacity to pay, then I must let it go ahead as the entire EMI payment is going towards decreasing the Principal amount.

    Please recommend what should I do from the following:
    1. Continue with deduction of EMI equivalent payments? in this case, I'm not sure if these payments towards principal amount are allowed during the moratorium period. Can the bank penalise me for making these payments towards the principal during the moratorium period?

    2. Get this anomaly corrected?

    Any help on the above would be greatly appreciated.


    • #3


      Re : Home Loans: Revisiting the basics

      Home loan: Loan switch

      While you won’t have to pay prepayment penalty on floating rate loans, you need to calculate net gains as new lender will charge processing fee

      From now, banks will not levy any foreclosure charges or prepayment penalty on home loans that are on floating interest rates. Though some banks like Axis Bank had already stopped charging prepayment penalty a few months ago, the Reserve Bank of India's recent circular will bring in uniformity across the sector. Currently, around 80% of the outstanding home loans of banks are on floating rate basis and the lenders are increasingly focusing on the floating rate to protect themselves from interest rate fluctuations.

      However, for fixed-rate loans, banks will continue to charge the prepayment penalty unless the amount is paid out of the borrower’s own funds. And home loan borrowers with dual rate loans from housing finance companies will still have to pay a penalty for early payment. From 2010 till late last year, when interest rates were rising and home loan disbursals were declining, banks and housing finance companies offered dual rates. It was initially led by the country's largest lender, State Bank of India, and, later, followed by all banks in the public and private sector and even housing finance companies.

      The central bank, in its circular, says the removal of prepayment charges will reduce discrimination between new and existing borrowers and competition among banks will result in finer pricing of floating rate loans. Analysts, however, say foreclosure does not make much sense if the borrower prepays after 10 years of the existing loan as he would have paid the maximum interest by then.

      Also, the borrower will lose out on tax incentive on interest paid. Section 24 (b) of the Income Tax Act, 1961, allows a deduction of interest payment up to R1.5 lakh from taxable income for self-occupied properties and, under Section 80C, principal payment up to R1 lakh, inclusive of other investments, can be deducted from the income while calculating the tax liability.

      “Prepayment makes sense if one is doing it in the first 4-5 years of the loan when the interest outgo is maximum. A borrower should ideally save or liquidate assets yielding lower returns to prepay a part of the full amount. But one must keep some cash, ideally in short-term fixed deposit or liquid funds of mutual funds for any emergency,” says Brijesh Damodaran, founder and managing partner of Zeus WealthWays LLP.

      The RBI, in its annual monetary report, had underlined that it will not permit banks to levy foreclosure charges on home loans on a floating interest rate basis, a point that was emphasised by the Committee on Customer Services in Banks headed by former Sebi chief M Damodaran. The committee had observed that foreclosure charges levied by banks on prepayment of home loans were resented by home loan borrowers across the board, especially since banks were found to be hesitant in passing on the benefits of lower interest rates to existing borrowers when the interest rate moves down.

      Analysts also say foreclosure charges are seen as a restrictive practice deterring borrowers from switching over to cheaper available sources.

      “The removal of the prepayment penalty will make it easier for customers to shift loans to other banks if they get a better interest rate. Borrowers must negotiate with the bank as banks would also not like to lose a genuine customer with a good repayment track record,” says Arun Duggal, a Delhi-based financial planner.

      Of course, the new lender will charge a processing fee for the loan and the borrower must calculate the net gain of switching the loan.

      Bankers, however, say that by charging for prepayment, they manage their asset-liability gaps better and stop borrowers from shifting to other banks. Some banks, till now, did not charge any penalty if the borrower paid from her own source of funds and did not take any fresh loan to prepay the existing loan. In some cases, no prepayment charge was levied on the borrower if she paid up to 25% of the principal outstanding in the first 2-3 years of taking the loan.

      However, prepayment done above that attracted a penalty of 1-3%, depending on the bank and the initial clause set up in the agreement.

      In fact, in May last year, the government had advised public sector banks, the Indian Banks’ Association and the National Housing Bank not to levy prepayment charges when the loan amount is paid by the borrowers out of their own funds. If any prepayment charges are to be imposed on housing loans, they need to be reasonable and transparent and not out of line with the average cost of providing the services. Own funds means money generated by the borrower from his personal source and not via borrowing from a bank or non-banking financial institution.

      Financial planners say since a home loan is backed by an asset where the price moves up in the long run and the burden to service the loan decreases with a rise in income, it is advisable to wait if you have age on your side. But if the number of productive working years are less, it is better to pay off the entire loan as early as possible.

      Maintaining a fine balance

      * For fixed-rate loans, banks will continue to charge the prepayment penalty unless paid by own fund

      * Home loan borrowers with dual rate loans from housing finance companies will still have to pay a penalty for early payment

      * RBI says the removal of prepayment charges will reduce discrimination between new and existing borrowers and competition among banks will result in finer pricing of floating rate loans

      * However, foreclosure does not make much sense if the borrower prepays after 10 years of the existing loan as he would have paid the maximum interest by then

      * The new lender will charge a processing fee for the loan and the borrower must calculate the net gain of switching the loan

      Home loan: Loan switch
      Please read IREF rules | FAQ's


      • #4


        Re : Home Loans: Revisiting the basics

        Thank you so much MANOJa - very helpful article for me as I'm just about to venture on a housing loan


        • #5


          Re : Home Loans: Revisiting the basics

          Prepaying: Do look at home saver option

          Victor has taken a home loan for Rs 25 lakh and is regularly paying the EMIs. Despite the interest rate increases, he never defaulted. He has even made a lump sum payment of Rs 5 lakh towards part pre-payment. It was going well until Victor had an emergency expense of Rs 3 lakh, and could arrange for funds with some difficulty.

          This is not an uncommon situation. Many borrowers can easily identify such instances where pre-payment of loan puts an extra burden on them as it ate into their savings, leaving them with no contingency measures to face any emergency.

          Pre-payment of home loan is a double-edged sword. It reduces the future obligation but incurs opportunity cost and more risk in case of emergency situation.

          Home Saver Loans

          What if there is option where loan borrowers can pay more (just like in case of pre-payment) when they have surplus funds and withdraw from the same fund when they face emergency situation like what Victor faced? The 'home saver loan' is one such option that not only allows home loan borrowers to pay more in times of surplus and lets them withdraw from the same pool to meet emergencies.

          How it works

          The idea is to make use of your deposit in current or savings account to offset some part of the principal. Once a part of the principal is offset, your interest obligation comes down. Let us understand this with the same example.

          Suppose Victor, instead of paying Rs 5 lakh as prepayment, would have deposited Rs 5 lakh in his current or savings account linked to his home saver account and left it at that. His interest obligation would have been calculated on the loan outstanding minus Rs 5 lakh. What is more is that Victor can withdraw this money or a part of it whenever he wants it. Let's see how this works by an example. (See table)

          It can be clearly seen that the borrower has saved more than Rs 3,000 in the first month itself. This saving can be huge if you consider the fact that you have to pay the EMIs over several years.

          What if you do not have Rs 5 lakh in your current/savings account? In that case, even when you make a recurring deposit in your account, this deposit will be subtracted from the principal outstanding to calculate the EMI. The savings would be less in initial months but will compound in the later part of the tenure.

          Home saver accounts will not only help borrowers save on payment but will also reduce the tenure of EMI as principal will reduce with every passing month.

          Important points

          This is certainly an innovative loan product but it has its own pitfalls. First, keeping money in a savings or current account is not profitable. Investors would rather start SIP in mutual funds, which can give better returns.

          While liquidity is an issue in case of mutual funds relative to savings or current account, this is manageable as redemption of mutual funds can happen in few days.

          Secondly, home saver loans are given at a higher rate than normal home loans. Banks typically charge anywhere between 0.5-1 per cent higher rates than normal home loan. Despite the higher rate, the overall savings is tremendous.

          Finally, this option is relatively better only when you have enough money to park in the linked account. Moreover, the home saver loan is not offered by all banks as of now. Few that offer it are: Citibank, Standard Chartered Bank, IDBI Bank, HSBC, ICICI Bank, and State Bank of India. The rates vary with banks. Borrowers should also look at the criteria for eligibility as this is different from normal home loan where banks have similar criteria. A little shopping around would help.

          Prepaying: Do look at home saver option - Indian Express
          Please read IREF rules | FAQ's


          • #6


            Re : Home Loans: Revisiting the basics

            Making the most of your loan tenure

            Close on the heels of RBI slashing its SLR rate by 100 basis points to 23 per cent, the State Bank of India has announced a cut in the home loan and car loan interest rates with effect from August 7, 2012. Home loan interest has been cut to 10.25 per cent from the existing 10.50 per cent for loan amounts below Rs 30 lakh, whereas the loan amount between Rs 30 lakh to Rs 75 lakh will now attract interest at the rate of 10.40 per cent.

            The maximum cut of 85 basis points has been announced on the loan amount above Rs 75 lakhs. The banking sector is expected to follow the trend with increased liquidity in the days to come. The base rate is standing unchanged at 10 per cent at the moment, so existing bank borrowers would not get the benefit of any rate reduction.

            On the other hand the loan repayment can be up to a maximum of 30 years or until the borrower reaches the age of 70, whichever happens earlier. Also, other aspects to note include a loan conversion option for existing borrowers with the base rate being retained at 10 per cent. A processing fee for procuring loans apart from which there will also be property verification fee, stamp duty charges that will be applicable for the loan applicants also need to be accounted for in the total cost equation.

            Other banks are expected to follow suit with the festive season just around the corner. As always several aspects need to be considered before opting for a loan in the current situation. In this article we will explore the relationship between EMI and loan tenure.

            When you start out to repay your home loan generally, the repayment schedule is worked out in a manner that allows not more than about 40-50 per cent of your monthly gross income to be repaid as EMI.

            If you invest too much into it, there might not be adequate funds to manage a huge list of other expenses that will tend to accumulate with time. For example, you need to make allowances for future expenses like education of children, emergency funds for a job loss or the loss of one income in a situation where two people have taken a joint loan.

            In such a situation especially in the current context where inflation is eating into everyday expenses a loan repayment with a maximum tenure can ease the monthly burden and help you manage the loan with ease. You can enjoy this benefit in the short term but always set a long term goal to try and close your loan before the maximum tenure ends.

            Also, in another scenario, there might be spikes in interest rates. Usually banks will increase the loan tenure in order not to put the loan taker in a tight spot by increasing his EMI. To help save on the total interest outgo on your loan, if you have adequate funds in hand you could prepay at intervals, allowing scope for closing your loan early. When you make a part-payment, the amount will be deducted directly from your principal, which means you will pay up your loan faster than the term it requires. Remember the longer the tenure the more the interest you will be shelling out. Try to prepay during the first half of your loan tenure as your interest part of the EMI is the highest during the initial stages and becomes smaller towards the latter part of the tenure. (See illustration)

            Hence, regular prepayment, whenever you are allowed to start prepaying can help you save significantly on the money you shell out in the long term for your home loan. You can use online calculators available to calculate the amount of interest you will actually shell out with an increase in tenure and lower EMI.

            Making the most of your loan tenure - Indian Express
            Please read IREF rules | FAQ's


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