A checklist of things that you ought to do before putting pen to paper on a home loan deal – By Abbas Naheed
Although in these times you can’t say this with any amount of certainty, the economy does seem to be getting better. And real estate has usually been a sector that has provided the economy some momentum. Current market conditions — lowering mortgage rates, stabilized or increasing home prices and the various attractive real estate offerings in select geographies − favor a stronger housing sector in times to come.
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. Personal finance check
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 outflows. It is a prescribed personal finance practice to get a new monthly budget in place which accommodates the new cash outflow in the form of EMI payments.
What one can afford should be determined by one’s ability to service the repayments of the liability one undertakes with a home loan. This would be governed by the loan amount and the interest rate applicable on one’s home loan. One also needs 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 one settle one’s 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.
Therefore, it makes sense to access one’s affordability and the loan’s impact on one’s personal finance before opting for a home loan.
2. Check 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 one’s previous credit card usage, how one maintained bank accounts, any check bounces, existing loans, uninsured existing loans, loan repayments, how many times one has 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 one applies for a credit card or any sort of loan.
The type of interest rate one chooses has an impact on the EMIs. It is important to know the difference between fixed rate home loan and floating rate home loan
For many, paying the processing fee to know the maximum limit at more than 3 or 4 banks seems to be a good idea. Well, this happens to be one of the common mistakes committed by many people. The more times one applies for a loan, CIBIL considers it as being credit hungry. So the chances of getting a loan are minimized.
3. 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 (eg: LTA, Medical allowances, etc.). They only consider the income heads which can be used to repay one’s loan.
4. Type of interest rate
The type of interest rate one chooses has an impact on the monthly EMIs one pays. It is important that one knows the difference between fixed rate home loan and floating rate home loan. For instance, if one opts 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 have become quite rare today. Besides, these are usually 1-3% higher than floating interest rate products, but bring a certain level of certainty to one’s financial planning since one is more or less certain of one’s 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.
One 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 one may want to build into one’s financial planning.
A person should also remember that different banks offer different interest rates on home loans. Therefore, one must negotiate with them to get the best possible rate.
Once again, keeping in mind how much one can afford to pay each month, one should 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 one would pay as interest over the term of one’s loan would be substantially lower. If a person can’t afford the higher EMI and have to necessarily take a higher duration loan, it would help to try and manage one’s savings in a way that help one pre-pay the loan with intermediate payments in the initial years itself so as to reduce the overall interest burden.
What one can afford will also be reviewed by the bank that is providing the loan. This would depend on 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 light of this, in case one wants a loan of an amount higher than what is being offered as an individual, one may want to have one’s spouse or parents as co-applicants. This helps to 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. This however, can only work if the coapplicants have an independent source of income.
Having co-applicants sometimes also makes sense from a taxation perspective with each applicant being able to avail the tax benefit available on interest payment of an EMI.
7. Pre-payment and foreclosure charges
One of the important features that should be considered in home loan product is the availability of pre-payment facility. While some banks may not allow one to prepay loans, others could be providing the facility to prepay a certain percentage of the principal amount every year with or without a penalty charge. Here, it is worthwhile to compare this feature across the product options one is evaluating since this flexibility can help one reduce interest burden if one can manage to close the loan earlier.
8. Read documents carefully before you sign
One shouldn’t let the bunch of home loan documents bog one down and just sign on the dotted lines. Check the documents to ensure that the terms are same as what were 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 prepaying the loan.
9. Implications of delayed payments
Delayed or missed payments can impact one not only financially, but can also affect the credit history of an individual. On the one hand, one may have to pay a penalty or fees associated with delayed or missed payments, while on the other one’s credit history will reflect these missed or delayed payments.
So, always try to clear EMIs in time because once a person is declared a defaulter or one’s credit history turns bad, then it becomes too difficult to take a home loan again from another bank or housing finance company. It will also become very difficult to transfer loan to another bank or lending institution which is offering a lower interest rate. Not only this, with a bad credit history, one also won’t be able to take even a personal loan henceforth. Therefore, it is better to be safe than sorry.
10. Balance transfers
Having taken a loan, one may at some stage be tempted to transfer loan to another bank or lending institution which is offering a lower interest rate than one currently has. While taking this decision do make sure that one factor in any foreclosure costs associated with one’s existing loans (charges linked with an early closure of one’s loan). The bank one is transferring one’s loan to may also be charging processing fees. Take these costs into account and ensure that the savings made on lower interest rate are higher than the costs associated with loan transfer.
11. Cover your liability
Given the long-term nature of the liability, it also makes sense to protect oneself and one’s family from any unforeseen circumstances. In this case one can consider a life insurance plan.