5 Things to know before taking a Home Loan

Buying a house is an important step in one's life. Remember the song "Ek Bangla Bane Nyara" by KL Sehgal? I took the plunge some time back and like most of the normal people, I took a home loan to help me in this. Today, I'll share the few things that I checked while taking the home loan - 

1. What is your eligibility?

Home loan amount depends on your income, outstanding loans, credit card dues, previous payment records. Banks like to understand how much can you spare for the EMI. You should also be clear about the amount that you are willing to pay every month as EMI. As a rule of thumb, anything more than 40-50% of your monthly income would be difficult to pay regularly. Call a few banks and check about your maximum eligibility. It usually takes your last few salary slips to know an accurate amount.

Usually banks fund 80% of the property value as loan, rest of it would come from your savings. Thus, the maximum eligibility might not be the sole thing you need to consider.

2. Know your Credit Score (CIBIL)

Check with Credit Information Bureau (India) Limited (CIBIL) to know your credit score. It gives you a credit score on the scale of between 300 and 900 points. The points are given on the basis of your credit card bill payment, bank account statement, existing loans or liabilities, loan repayments and how many times you have applied for loan till date.

People sometimes apply at multiple banks to know their maximum limit. This is considered to negatively impact your CIBIL score and your chances of getting the loan reduces.

While it is a good idea to know this number so that you can use it if needed, I was not asked about it.

3. Loan Tenure and Interest Type

There are banks who provide a Fixed Rate loan as well a Floating Rate. While many of them now just provide a Floating Rate, some of them also combine the two, a Fixed Rate for a the first few years and a Floating Rate afterwards. It helps to have a fixed EMI in the initial years when the interest outflow is high.

The EMI also depends on the tenure. Based on the amount that you plan to let go every month, you should decide the Loan Tenure. A higher tenure means more interest outgo over the complete period, so you need to strike a balance.

4. Choose your lender

Do a detailed research to find a bank or financing company for home loan. Check with at least 4 to 5 banks and companies to know their terms and conditions of offering a loan, interest rate and tenure.

While the interest rate is important, you should also look at other aspects such as the customer service, charges for early termination of the loan and more before deciding the financier. 

It is now a norm to provide the ability to prepay your loan anytime without any additional charges. This would affect you if you want to prepay the loan.

5. Extra Charges

Get complete information about the extra charges that you will have to pay to take a home loan like processing fee, service and administrative fee, etc. These charges are a percentage of your loan amount that is actually sanctioned to you, and not on what you actually take home. Making modification in any of these later may come at a cost. Some banks want you to register the loan agreement at the sub-registrar.

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Should you Invest Or Repay your Loans?

Found this article on Outlook Money (Dec 30, 2009 issue) and thought to share it on this platform.

The traditional wisdom says that you probably shouldn’t be investing while in debt unless you can reasonably expect to outperform the interest rates that you’re paying. In other words, if you’re carrying a high-interest debt, you should focus on getting out of debt instead of building your portfolio. This sounds simpler than it is.

What you should do will depend on two factors: the rate of after-tax interest that you are paying on your debt; and the after-tax return that you will be earning on your investments. Understand the types of debt and their impact on your financials.

One type of debt is the high-interest credit card debt, which is mostly used to meet comforts and luxuries, not needs. This kind of debt will eat your financials like a termite and should be avoided unless absolutely necessary.

The other type of debt is the lower interest rate variety, like housing loans, education loan, etc. Often the interest payable on these loans is either fully or partially tax-deductible, thus making them even more attractive.

If your cash flows support you in terms of meeting the debt prepayment and you still have surpluses, you can continue to invest and pay your debt at the same time. For example, you have a housing loan for which you are paying monthly EMIs. Treat this EMI as monthly rent and continue the debt, as you also get tax benefits for the interest portion on the housing loan. Invest the surplus in the asset type depending on your risk appetite. There’s certainly no harm in carrying the loan while building up your investments for the future. In fact, if you wait until you’ve paid off your loan over 15 to 20 years, you’ll find yourself in a very difficult situation by the time you turn your attention to the future. In case your cash flows are not very predictable, and you have surplus today, it will be better to clear the debt and reduce or zero your liabilities rather than investing the surpluses. Imagine a situation where you have invested in the market with the hope of generating returns that are more than what you are paying for the debt. Suppose the markets fell and your investments lost half of their value, while, at the same time, your cash flows took a hit. You will have a couple of painful choices to make—either you sell your investments at a loss and meet your commitments, or borrow afresh at a higher rate. It is better to clear your debts and then start your investments. The illustrations below will help you decide whether to continue the debt or to retire it.

Example I. You have an outstanding balance of Rs 50,000 on your credit card and you are paying 24 per cent annually and the interest is also not tax deductible. In such a situation, you should invest only if you think you can earn over 24 per cent per annum. Historically, the long term returns from equities have been around 18 per cent. It would be detrimental to your financial health to invest in a situation like this. So, clear the debt and use credit cards only if absolutely necessary.

Example II. You have a housing loan of Rs 20 lakh at 9 per cent, to be paid over 20 years. Let us also assume that you are in the 30 per cent tax bracket and as per current tax laws interest up to Rs 1.5 lakh is deductible from your taxable income. This will bring down the cost of your loan further. In such circumstances, it will be wise to continue your EMI of housing loan and the balance surplus is invested in long-term assets to generate returns higher than the interest cost.

What are you waiting for? Work out the numbers, see which is financially economical and just execute it even if it means you have to make a few painful decisions. Remember: “No pain, No gain”.

money.outlookindia.com Invest Or Repay?

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