All about Home Loan

Most of us are either having a home loan or are planning for one to purchase that dream home. This article is an attempt to demystify the basic home loan terms.

Eligibility for home loan

The amount of loan is decided mainly based on the value of the property and your repayment capacity. The lender will do the valuation of the property to assess the value of the property. Please don’t mistake this as the market value of the property. If the value of the property is 40 Lakhs, you will have to add around 10% of it (around 4 Lakhs) towards the stamp duty and registration charges. Earlier lenders used to add this cost also to arrive at the quantum of loan. But RBI stopped this practice to stop the speculation in real estate sector.

As per the current RBI regulations, you can get 80% of the value of the property as loan if the cost of the property is above 20 Lakhs. If the value is less than 20 Lakhs, this can go upto 90%.In our example of property valued at 40 lakhs, you can get 32 Lakhs as loan. You should plan for the down payment of balance 8 lakhs and the stamp duty & registration charge of 4 Lakhs. A total of 12 Lakhs from own pocket.

Different types of home loan

There used to be 2 types of home loan earlier, Fixed Rate and Floating rate. Now there is one more category added to it – Teaser Loan!

In a fixed rate loan, the interest rate will remain fixed throughout the term of the loan, while in the case of floating rate loan, the interest rate will change, as per the market rate of interest.

In Teaser loans, banks offer an initial interest rate which is lower than the market rate. So, they would just charge you 8% in the first year, and then say 9% in the second year, and then move to the market rate from the third year onwards. This will make a big difference on your EMI from 3^rd year! This is now stopped after RBI intervention.

At present the floating rate loans are more popular and the interest rates are in the range of 10-14 % depending upon your loan amount, credit score, relationship with the lender etc.

Tax Benefits on Home Loan

Home loan repayment through EMI consists of 2 parts – principal and Interest. Both of these are eligible for tax deductions.

Under Section 80C, you will get exemption upto 1 Lakhs for the principal repayment. But this limit of 1 Lakhs is applicable to your PF, PPF, Insurance premium, Tuition fee paid etc. In most cases, you will already have 1 Lakh under this section, which will make the principal repayment out of the tax benefit.

But the interest paid upto 1.5 Lakhs in a year is eligible for deduction under section 24. What is more? If you go for a joint loan with your wife, she can also claim upto 1.5 lakhs deduction. If you are going for a second home loan, then there is no limit of 1.5 Lakhs. You can claim the entire amount of interest paid as deductions!

Prepayment Penalty

Earlier banks used to charge penalty, if you preclose your loan. After lot of criticism and after strong regulatory intervention, now, banks and housing finance companies stopped charging penalty in case of prepayment of home loan on floating rate basis. But in the case of fixed rate loan or Teaser loan, it is still there.

BPLR and Base Rate Linked Loan

Earlier home loan interest was linked to the Prime Lending Rate of the bank. Later, banks switched over to a more transparent system called Base Rate. This results in better rates for the new customers and higher interest rates for the existing customers. But now banks are permitting old customers to switch over to the Base Rate linked loan, after charging a small penalty. Still it makes sense for the old customers to switch over to the new system which is more transparent.

Effect of a 3% increase in loan interest

Suppose you have taken loan for 30 Lakhs for a 15 year term at an interest rate of 8%. The EMI will be around 28670/-. Suppose the interest rate is increased to 11% after you have paid 12 EMIs. There are 2 ways to handle this situation.

1. Increase the EMI. In this example, the EMI for the remaining 14 years will be 33810/-. An increase of 5140 or 18%.
2. Ask the bank to increase the term of the loan, without increasing the EMI. In this example, if he continues to pay the same EMI of 28,670, his loan repayment term will be extended by 9.5 Years! In some cases, it may stretch beyond your retirement age.

Don’ go for a loan, as per your eligibility, but go for loan, as per your repayment capacity. Arrange for a large down payment and go for the minimum loan, which you can repay comfortably even if there is an increase in interest rate.