By Sanjeev Sinha, ECONOMICTIMES.COM | 17 May, 2013, 02.58PM IST9 comments |Post a Comment
Before opting for a loan, it is advisable to assess impact of taking a loan & subsequent EMI payments on the monthly cash out flows.
Buying a home is an important personal finance decision for every individual, particularly in view of the fact that a home is usually the biggest investment in one’s lifetime. And like anywhere else in the world, home loan or mortgage products have only made it easier for average salaried Indians to own a home they can call their own. One should, however, not forget the long-term liability that needs to be serviced and it would only help to keep some of the following things in mind when taking a home loan:
1. Impact of loan on your personal finance
Before opting for a home loan, it is always advisable to assess the impact of taking a loan and the subsequent EMI payments on the monthly cash out flows. It is a prescribed personal finance practice to get a new monthly budget in place which accommodates the new cash out flow in the form of EMI payments.
“The impact should be analyzed on the monthly available surplus and subsequent savings being done towards achieving other goals. This helps in determining the comfortable EMI payments one can make and respective loan amount one can opt for,” says Nitin B Vyakaranam, founder & CEO of financial planning portal Artha Yantra.
In other words, what you can afford should be determined by your ability to service the re-payments of the liability you undertake with a home loan. This would be governed by the loan amount and the interest rate applicable on your home loan. “You also need to remember that taking a loan with a view of selling the house a few years down the line at a higher price to help you settle your liability may not always work, especially if the property prices start moving downwards or even if they remain static – as we have seen over the last couple of years the world over,” observes Anil Sahgal, director, MAGI Research and Consultants, and co-founder of personal finance consulting portal ‘i-save’.
Therefore, it makes sense to access your affordability and the loan’s impact on your personal finance before opting for a home loan.
2. Know your maximum loan eligibility
As per the current market norms, banks can lend up to 60 times the monthly net salary of an individual. However, while assessing the income criteria, they do not consider some of the salary slip heads for calculating the net monthly income. They only consider the income heads which can be used to repay your loan.
“For example, your LTA and medical allowances are deducted from the monthly net salary you receive. You are expected to spend the amount received under these heads for the specific activities they are being provided for. This is one of the reasons why we generally see a difference in the eligibility amount quoted in the website and actual amount realized once the application is processed,” informs Vyakaranam.
3. Check your CIBIL score
The home loan eligibility depends on credit worthiness of the individual. Credit Information Bureau India Ltd (CIBIL) provides a credit score on a scale of 300 to 900 based on your previous credit card usage, how you maintained your bank accounts, any check bounces, existing loans, uninsured existing loans, loan repayments, how many times you have applied for loan or a credit card. Individuals with a CIBIL score greater than 700 are more likely to get a home loan. All the home loan lenders approach CIBIL for this score whenever you apply for a credit card or any sort of loan.
“Paying the processing fee to know the maximum limit at more than 3 or 4 banks is one of the common mistakes committed by many people. The more times you apply for loan, CIBIL considers it as being credit hungry. So the chances of getting a loan are minimized. CIBIL rating, net salary excluding some variable heads and existing loans and EMIs being paid towards existing loans are the vital components which decide the repayment capacity of the applicant,” says Vyakaranam.
What you can afford will also be reviewed by the bank that is providing you the loan. This would depend on your past and current financial position and ability to service the loan in the future i.e. ability to pay back the loan with applicable interest.
“In case you want a loan amount higher than what you are being offered as an individual, you may want to have your spouse or parents as co-applicants. This helps you increase the overall limit that the bank can offer since there is more than one person sharing the repayment of loan and the combined limit will obviously be higher. Needless to say, this can only work if the co-applicants have an independent source of income,” says Sahgal.
Having co-applicants can also make sense from a taxation perspective with each applicant being able to avail the tax benefit available on interest payment of an EMI.
Once again, keeping in mind how much you can afford to pay each month, try and keep the duration of the loan as low as possible. With a lower duration of loan, the EMI may be higher but what you would pay as interest over the term of your loan would be substantially lower. If you can’t afford the higher EMI and have to necessarily take a higher duration loan, it would help to try and manage your savings in a way that help you pre-pay the loan with intermediate payments in the initial years itself so as to reduce your overall interest burden.
6. Type of interest rate
The type of interest rate you choose has an impact on the monthly EMIs you pay. It is important that you know the difference between fixed rate home loan and floating rate home loan. For instance, if you opt for fixed rate home loan, the EMIs don’t vary over the loan tenure. So it is beneficial when the interest rates are expected to rise in the near future. In case of floating rate home loan, interest rate is determined based on the prevailing base rates, plus a floating rate. The EMIs vary based on the movement of base rates. It is beneficial when interest rates are expected to fall in near future.
But the choice on this one is not really easy. Fixed interest rate products are usually 1-3% higher than floating interest rate products, but bring a certain level of certainty to your financial planning since you are more or less certain of your monthly outgo. On the other hand, floating interest rate products, though cheaper, are linked to a base rate or benchmark rate and can go up or down with a change in the base rate.
“It would, therefore, make sense to go in for a fixed rate product only if you think the interest rates in the economy are bound to go up over the next few years. Even in this case, if the spread between the fixed and floating rates is fairly high, floating rate options continue to be better. For e.g. if the rate on fixed and floating rate products is 12.5% and 10%, respectively, then as long as the increase in base rates is lower than 2.5%, floating rate products continue to be cheaper,” says Sahgal.
You may also want to check the terms and conditions associated with a fixed rate product. At times, the fixed rate is applicable only for a limited number of years, which in any case will defeat any assumption of certainty that you may want to build into your financial planning.
You should also remember that different banks offer different interest rates on home loans. Therefore, you must negotiate with them to get the best possible rate.
7. Pre-payment and foreclosure charges
One of the important features that you should consider in your home loan product is the availability of pre-payment facility. While some banks may not allow you to prepay your loans, others could be providing you the facility to prepay a certain percentage of your principal amount every year with or without a penalty charge.
“It would be worth your while to compare this feature across the product options you are evaluating since this flexibility can help you reduce your interest burden if you can manage to close your loan earlier,” says Sahgal.
8. Read the documents carefully before you sign
Don’t let the bunch of home loan documents bog you down and just sign on the dotted lines. Check the documents to ensure that the terms are same as what you negotiated and agreed upon. Read the documents carefully and know the different charges applicable. Importantly, know the processing fee, late payment fee and any charges that are applicable for pre paying the loan.
9. Take cover
Given the long-term nature of the liability, it also makes sense to protect yourself and your family from any unforeseen circumstances. In this case you can consider a life insurance plan.
“A life insurance plan that covers the re-payment of loan in the event of an unfortunate death of the borrower can at least help the family retain their home,” says Anil Sahgal.
10. Loan transfers
Having taken a loan, you may at some stage be tempted to transfer your loan to another bank or lending institution which is offering you a lower interest rate than you currently have. While taking this decision do make sure that you factor in any foreclosure costs associated with your existing loans (charges linked with an early closure of your loan). The bank you are transferring your loan to may also be charging you a processing fees. Do take these costs into account and ensure that the savings you make on lower interest rate are higher than the costs associated with the loan transfer.
11. Implications of delayed payments
Delayed or missed payments can impact you not only financially but can also affect your credit history. On the one hand, you may have to pay a penalty or fees associated with delayed or missed payments, while on the other your credit history will reflect these missed or delayed payments.
You should, therefore, always try to clear your EMIs in time because once you are declared a defaulter or your credit history turns bad, then it will become very difficult for you to take a home loan again from another bank or housing finance company. It will also become very difficult for you to transfer your loan to another bank or lending institution which is offering you a lower interest rate. Not only this, you also won’t be able to take even a personal loan in your entire life. Therefore, it is better to be safe than sorry.