What is Home Loan

Home loan is a secure source of finance to ensure that you can actually accomplish your dream of having your very own home which eventually acts as a security for you as well. Home loans are offered against security of a property (commercial/residential). The borrower generally approaches a bank or a financial institution, which sanctions the loan against mortgage of the property that is intended to be bought by the applicant. An arrangement of conditional ownership is entered into, whereby, in the unfortunate event of the borrower defaulting in his/her instalment payments, the bank/financial institution can retrieve the lent money by selling the property against which the home loan had been sanctioned. In most cases the mortgage continues till the last instalment of the loan has been paid.

Types of Home Loan

There is a wide variety of home loans on offer.

  1. Home Purchase Loan: for buying of a property.
  2. Home Improvement Loan: for carrying out renovation and repair work of an existing home/apartment.
  3. Home Construction Loan: for building of a new house
  4. Home Extension Loan: for expanding the current area. i.e. constructing an extra room.
  5. Land Purchase Loan: for the acquisition of land to construct a home, or even for investment purpose.
  6. Loan for the self-employed: for utilisation by small retailers, self-employed individuals, doctors etc. This is a custom made type of loan.
  7. Plot loan: for purchasing non-agricultural plots (applicable all over India)
  8. Home Loan Transfer: for transfer of loans from other institutions or Banks
  9. Home Conversion Loan: for financing a new home which the owner wants to shift to from a home that is already being financed by an existing home loan. This new loan pays back the existing loan and provides the extra money required for the new establishment.
  10. Bridge Loan: for sustaining the borrower through the interim period, when he wants to sell an existing some and buy a new one. It is a short term loan that sees the individual through till he/she has found a buyer for the old establishment.

Some banks provide specially designed home loans for the rural segment of the population including agriculturalists, horticulturalists, dairy farmers etc. The loan is provided for construction of houses on residential plots, purchase of new houses, and also for extending and renovating an existing house. These loans are provided after gauging the applicant’s financial status and if found satisfactory, loan is granted without the mortgage of agricultural land.

Why is it more convenient to take a Home Loan?

Before taking the plunge to buy a property it is always wise to weigh the options of using up your savings or to avail of a home loan. Generally, it the advantage of the latter that outweighs the former on the basis of the following points:

  1. Bank inspection
  2. The buyer of a property wants to make sure that all papers, relating to the title of the property to be bought, are clear from any discrepancy. However, prior to approving home loan, the same inspection is carried out by the Bank professionals. This makes the process more reliable and trustworthy.
  3. Credit history
  4. Since home loans are long term loans, it gives individuals a scope to build a credit history. Moreover, when regular instalment payments are made towards repayment of the loan, the individuals are regarded as financially disciplined and rewarded by CIBIL (Credit Information Bureau of India Limited) with a high CIBIL score.
  5. Tax Benefits: Interest paid
  6. Section 24(b) of the Income Tax Act, 1961 states that a deduction up to Rs. 1.5 lakh towards the total interest payable on the home loan intended for purchase / construction of house property can be claimed while computing the income from house property. (The deduction stands reduced to Rs. 30,000 for loans taken before March 01, 1999).
    The interest payable for the pre-acquisition or pre-construction period is liable to be deducted in five equal annual instalments commencing from the year in which the house has been acquired or constructed.
  7. Tax Benefits: Principal Repayment
  8. The newly introduced Sections 80C with section 80CCE of the Income Tax Act, 1961 states that the principal repayment up to Rs. 1 lakh on the home loan will be permissible as a deduction from the gross total income subject to fulfilment of prescribed conditions.
    In case the spouse is a co-applicant, the joint loan holders** are separately eligible to enjoy the benefits during tax computation.

    ** A co-applicant is/are the co-owners of the property which is being offered as collateral security to the loan. However all co-applicants need not be co-owners. Co-applicants to the loan are generally husband/wife, father/son, etc.

What are the elegibility Criteria for Taking a Home Loan?

To qualify for a home loan some basic criteria need to be fulfilled. (The following list is not exhaustive; please check with the bank that you are dealing with)

The applicant must be-

  1. An Indian resident or an NRI
  2. Of minimum 21years of age at the commencement of loan
  3. Below 65 years of age when the loan matures
  4. Either salaried, professional or self employed

Other factors that influence the eligibility are the applicant’s monthly income (which in turn determines his/her ability to make a down payment), existing loans and the cost of the property that has been chosen.

Loan amounts may be sanctioned after or prior to purchase of a property.

Documents Required (at a glance)

(The following list is not exhaustive; please check with the bank that you are dealing with).

  1. Proof of identity
  2. Proof of address
  3. Proof of income (IT return, usually for last 3 years and salary slips as required)
  4. Bank statement of salary account (generally last 6 months) along with verification of signature
  5. Passport size photographs
  6. Additionally for NRI applicants there must be a valid visa stamping, work permit, duly attested letter by last employer and a copy of CDC (for those employed in merchant navy only)

These must accompany the completed loan application form.

Points to Consider before Taking a Home Loan

There are some points to ponder on before zeroing in on a particular loan.

  1. Eligibility criteria
  2. Before applying for a loan calculate your loan eligibility through the EMI*. Banks usually limit the instalments at 40%-50% of your salary (basic+D.A) after considering your existing liabilities, number of dependants and the stability of your income. The value of the property in question is also considered as banks cap the loan amount to 70%-80% of the property value. The loan tenure does not go beyond the retirement age of the first applicant, unless he/she has a stably employed adult co-applicant.

    * EMI (Equated Monthly Instalment) is the amount payable to the lending institution every month, till the loan is paid back in full. It consists of a portion of the interest as well as the principal.
  3. Type of Loan
  4. Loans come with two types of interest rate- fixed (unchangeable) and floating (fluctuates with the market conditions). Usually the fixed rate remains marginally higher than the floating rate. Though a fixed rate indicates a stable payback, yet for a long term home loan a floating interest scheme is more desirable as the market is bound to come down at some point or the other and the EMI too, will fluctuate along with the base rate. Though the nature of the clause varies from bank to bank it is usually invoked either after a fixed period or a sharp spike in interest rates. Therefore, a floating rate makes more sense unless if the economy promises a sharp rise in interest rates in the near future. In some cases the payment mode of partly fixed and partly floating is arranged to suit the customer’s needs.
  5. Offer document
  6. The offer document is filled with legal terms so it is better to properly understand the underlying meanings. Eg. “Defaulter” does not only mean a person who has been unable to pay an instalment. It may also include clauses like death of the borrower, divorce of the borrower (in case of co applicant), and when a criminal offence is committed by the borrower. It is also wise to pay special attention to ad-on charges and penalties.
  7. Rate negotiation
  8. When dealing with a bank the applicant has the right to negotiate the interest rate with the bank. If the applicant is a long standing customer with a clean record his/her chances of negotiation are better. However, it is best to keep in mind that the banks always have an upper hand in such dealings. The best time to go for such negotiations is the month end, when the bank remains more flexible to them.
  9. Choosing the Bank
  10. It is best advised to talk to the loan officers of several banks before zeroing in on one. The interest rates smart loan (prepayment option) and repayment clauses differ from bank to bank. So one must choose that lender who suits his/her requirement.
  11. Loan tenure
  12. EMI payable is inversely proportional to loan tenure ie. Longer loan tenure means low EMIs and shorter loan tenure entails higher EMIs.
  13. Fees and Penalties
  14. It is wise to be properly aware of the processing charge, pre-payment penalties, commitment fees and other miscellaneous (hidden) costs.

Interest Rates

Interest rate is dependent on the market conditions and hence is dynamic in nature. It is calculated either on annual, monthly or daily reducing basis.

  1. Annual reducing system is where the principal, on which the interest is paid, reduces at the end of the year.
  2. Monthly reducing system is where the principal reduces every month as the EMI is paid on it. EMI here is effectively less than the annual reducing system.
  3. Daily reducing systemis where the principal reduces from the day the EMI payment is made. EMI in this system is less than the monthly system.

Deduction that Can be Claimed

  1. Deduction on Interest
  2. In case one is both an owner and co borrower, he/she may claim the interest component in the EMI as deduction. The deduction claim may be initiated the year in which the construction of the house is completed. However, pre-construction interest may be claimed from the same year by adding the entire pre-construction interest and claiming the sum in five equal instalments. The total deduction, however, should not exceed Rs 2 lakh when the house is being used by one for one’s own residential purpose.
  3. Deduction on Principal payment
  4. Under section 80C of the IT Act, 1961, the EMI which goes towards the principal is eligible to be claimed as a part of the maximum amount of 1.5 lakh.
  5. Deduction on Stamp Duty and Registration Charges
  6. Section 80C also allows the claim on payment made towards stamp duty and registration charges (only in the year in which these were paid).
  7. Deduction under section 80EE
  8. This section has been inserted to provide tax benefit in the form of a deduction of a maximum of Rs. 1 lakh, to first time home owners, where loan had been sanctioned to them between 1st April 2013 and 31st March 2014. The value of the house/apartment should be Rs 40 lakh or less and the quantum of loan taken should be Rs 25 lakh or less. Deduction under this section can be claimed in financial years 2013-14 and 2014-15, spread over these two years or in any one year. This section lapses in the current financial year 2015-16. So, if you meet all the conditions laid out in Section 80EE, do remember to claim the deduction while filing your tax returns for financial year 2014-15.

Repayment Option

One repayment option is by giving a number of post-dated cheques for credit into your loan account with the lender.

Repayment may also be done though issuance of an adequate mandate to your Banker instructing them to debit the EMI amount on a specified date and credit it to the loan account of your lending bank. This saves you the trouble of keeping track of a bundle of PDCs over a considerable period of time.

Some banks are now providing the option of smart loans, whereby the borrower can prepay the loan amount partially if he/she has surplus fund. Under such circumstances, the borrower has the option of reducing the interest burden or increasing the EMI to reduce the tenure of the loan. Banks such as HSBC, SBI, and Standard Chartered have already introduced this scheme.