Five points to keep in mind while taking a home loan

Buying or building a house is most often the biggest financial investment for most individuals and families. Thanks to the easy availability of loans and relatively lower interest rates, home loans are now the preferred way to fund the purchase of residential property in India. This is even truer for first-time home buyers, who don't have the accumulated savings to self-fund a house.

If you are looking to purchase a home by taking a loan, it is important to understand all its aspects. A home loan is a financial commitment that will take years and the EMIs on the loan will consume a big part of your monthly disposable income. 

A small slip or a mistake here will potentially cost you a fortune over the loan tenure that will easily last most of your working life. 

Conversely, a well-researched and planned home loan can save you lakhs of rupees over its tenure and ease the entire process of acquiring and owning the property. 

Here are five things to keep in mind before you sign up for a home loan:

1. Loan eligibility criteria. Before applying for a loan, you should check out whether you would qualify for a home from your prospective lender and the maximum amount of loan that the bank will lend you. You can do the initial research online by visiting the portals of leading banks and housing finance companies and then you can contact the loan officers at their branches. 

The eligibility for home loans largely depends on your monthly income and repayment capacity. However, bankers also take into account factors such as age, educational qualification, job experience, the value of other financial and physical assets that you may own, number of dependents, spouse income and your credit score. Clarity on the eligibility and the maximum amount of loan that you can avail will make it easier for you to look for a property that will fit in with this ‘budget.’

2. Interest rate on a home loan. The interest on the loan is the biggest factor to keep in mind while availing of a home loan. The prevailing interest rate determines the monthly EMIs which in turn affects our repayment capacity. Compare the interest rate from various lenders and the monthly EMIs that they will charge for various tenures and then choose the one that is most affordable. 

As a rule of thumb, public sector banks, large private sector banks and leading home loan companies offer the most competitive interest rate while smaller home loan companies charge much higher interest rates on their loans. 

However, lower interest rates from top lenders come at the cost of greater paperwork and stringent eligibility criteria.

You should also decide whether to opt for a floating or a fixed interest rate. Floating interest rates could change every three months based on external factors such as changes in RBI’s base rate and conditions in the bond market. Fixed rates, as the term implies, do not change over time. 

Fixed-rate loans are thus safer on paper but the initial interest rate would be 3 to 4 percent higher than floating rates, which will reduce your repayment capacity and loan eligibility. 

Besides, most lenders prefer to give loans on a floating rate rather than a fixed rate.

Also Read: Retirement planning: Why NPS is better than mutual funds and ULIPs 

3. Loan Tenure. Many lenders now sanction home loans for a maximum tenure of 30 years, which translates into 360 monthly instalments. Higher tenure means lower EMIs and this lowers the monthly burden on your cash flows. 

On the downside, you are stuck with a large financial commitment for a better part of your working life, which may not be comforting for many. Longer tenure also means that you will pay more in interest during the life of the loan. 

That is why it’s advisable to restrict the loan tenure to within 15 years (180 instalments) or even 10 years (120 instalments) if you can afford it. 

This will save a lot of money on interest payments. The best way is to take a loan with 20-year tenure and then gradually reduce the tenure by increasing the EMI every year as your income and cash flows grow.

Also Read: How to calculate your net worth and use it to maximise financial gains

4. Total cost of your home loan. The total life cycle cost of your home loan will be much higher than the monthly recurring interest cost on the loan. In fact, interest is the most transparent and easily understood cost of the home. Most lenders impose other charges and fees on borrowers, some of which could be called hidden charges that you will incur years after the final loan disbursement. 

This includes initial processing fees, sanction and disbursement fees, administrative charges, prepayment penalties, conversion fees when the interest rate on the floating rate changes, etc. These non-interest rate charges would amount to paying up to 6 months’ worth of additional EMI on your loan. 

So add up the interest and non-interest charges and then compare the cost of the loan from various lenders. As a general rule, you should opt for a home loan from a lender that offers zero prepayment charges for floating-rate loans. 

You should also be able to convert your loan to a lower rate by just paying a nominal fee.

Also Read: Five financial planning tips for the self-employed

5. Down payment or the margin money. Regulations don’t allow banks and housing finance companies to fund the entire value or cost of the property. Most lenders finance only up to 80 percent of the total value of the property and you have to bear the balance, which is called the down payment or the margin money. To illustrate, if you plan to buy a house that costs Rs50 lakh, then you can avail of a maximum loan of Rs40 lakh and the remaining Rs10 lakh has to come from your own pocket or some other sources. 

So before you plan to buy a house, create a corpus to pay the margin money. Raising the share of margin money in the overall funding improves your loan eligibility criteria and lowers the repayment burden. So applying for a home loan should be the culmination of a savings and investment process started by you and your family a few years prior.

Happy home hunting! 

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

Also Read: Five ways to save money on your home loan

Look up our YouTube Channel