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Home Finance

If you have taken a home loan or plan to take one, you can avoid a lot of hassles and bitter exchanges with lenders if you know some basic facts about home loans. Following are few important things first-time home loan borrowers must know:

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Principal Amount

The principal amount will be the loan amount for which you approach the bank for a home loan. For example, if you have chosen a one-bedroom apartment that would have cost you Rs 20 lakh out of which you have already saved Rs 4 lakh and need the balance Rs 16 lakh as loan amount.

Down Payment

Banks require a loan seeker to contribute certain amount while buying a home. It can be in the range of 15 per cent to 30 per cent of purchase price depending on your lender and loan seekers credit history / income. However, applying for loan with a bank that requires lower amount of margin is always beneficial.>

Loan Eligibility

This is the amount that a bank will loan to customers after discounting their gross salaries and personal credit history. Each bank has certain set of calculations to derive loan eligibility from loan seekers net monthly income.

Example: Let us assume that your monthly income is Rs 25,000. Let's assume that the bank has specified that loan eligibility will be 40 to 60 times of net monthly income of loan seeker. Then we can derive that you will be eligible for a loan amount of Rs. 10 lakh to Rs. 15 lakh - which means that you will have to make up for the shortfall from somewhere else.

Co-applicant

It means joint loan applicant. Co-applicant can be father, mother, son, spouse or brother. Having a co-applicant who is earning regular income through business or monthly salary helps increase the loan eligibility.

Type of Interest Rates

There are two types of interest rates: fixed and floating rates.

Fixed Interest Rate

In this type of home loan, interest rate remains same for the entire tenure of a loan. But, few banks offer the option of interest rate to be reset after two to five years on the basis of their prime lending rates (BPLRs). Also, few banks give the option to switch either fixed or floating interest rate after completing five years of loan.

Example: If the bank is giving home loan at 10.75 per cent per annum fixed interest rate throughout its loan tenure then it will be eligible for a reset at end of every two years based on this bank's BPLR.

Fixed Interest Rate

Interest rates are linked to BPLR and change frequently during the tenure of loan.

Equated Monthly Installment (EMI)

This is the amount that a borrower has to pay to the bank every month for a given period of time (loan tenure) and this depends on the interest charged on your loan.

Processing Fees

Bank charges certain amount of fees to process the home loan. It differs from one bank to another. Few banks will have NIL amounts of fees whereas others may charge 0.3 per cent to one per cent of loan amount.

Pre-payment Charges

There are bank charges involved if one is pre-paying (paying the entire outstanding amount before the end of tenure) the loan amount. Different banks charge different pre-payment amounts. Usually, charges are in the range of 0.5 per cent to two per cent of the prepaid amount.

WHY EXISTING CUSTOMERS ARE CHARGED HIGHER INTEREST RATES?

Loans by banks are linked to their base rates (below which they cannot lend). The loan rate is usually base rate plus a margin, for example, base rate plus 50 basis points or bps. Banks arrive at the base rate after looking at their cost of funds and other factors. That is why it is different for each bank.


The base rate may change but the bank cannot alter the spread or the margin at which it has offered loans to existing customers. So, if the base rate comes down from 10% to 9.75%, the interest rate for existing customers will fall from 10.5% to 10.25% (considering a spread of 50 bps). However, banks can offer new loans at a higher or lower margin, say, base rate plus 25 bps. So, for a new customer, the rate will be 10% (base rate at 9.75%), while old customers will continue to pay 10.25%. Existing borrowers feel 'cheated' by such a difference in rates.


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WHY OUTSTANDING REDUCES AT A VERY SLOW PACE INITIALLY?

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No matter how high or low your EMI is, its interest component will be very high in the initial years. Let us consider that you have taken a loan of Rs 30 lakh for 20 years at an interest rate of 10%. Your EMI will be Rs 28,950. After two years, the outstanding will be Rs 28.95 lakh. For Rs 6.95 lakh that you have paid in these two years, the principal will fall by only Rs 1.05 lakh.


In the first five years, only 17.6% EMI will go towards paying the principal. In the first 10 and 15 years, only 23% and 31.5% EMIs, respectively, will go towards payment of the principal. The higher the rate of interest or loan tenure, the slower is the reduction in principal in the first few years of the loan. The timing of loan prepayment could be based on this calculation.

WHY BANKS INSIST ON CHANGING LOAN TENURE INSTEAD OF EMI?

How often have you seen a headline like this - "EMIs to come down as RBI cuts rate"? Every time the RBI cuts interest rates, you are made to believe that your EMI will come down. But this is not always the case.

Lenders prefer to shorten the tenure than change the EMI. The reason is convenience. This saves them the hassles of readjusting the EMI, changing the ECS mandate and accepting new post-dated cheques. For most borrowers, EMIs remain the same for the entire loan tenure, and it is the principal-interest ratio that keeps changing.

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