Basics of a home loan

Basics of a home loan
3 Feb, 2008, 0544 hrs IST,Kavita Sriram, TNN

Times are fast changing. Remember when your father purchased a house? In all probability, it was when he was close to retirement. It was possible to have saved enough money to buy a house only after years of working.

Supplemented with his retirement money, he could have managed to purchase a house. Today, many homeowners are young people in their thirties. Thanks to banks offering loans and increased earning capacities, buying a house is no longer a distant dream.

Borrowers can live in the property, even when they are still repaying the loan. At the end of it, you have an asset that has multiplied manifolds in value. Home loan enables you to do just that.

Banks give home loans for constructing a home or purchasing a ready-built house, flat or residential plot. They even re-finance existing loans that borrowers may have availed from other banks. The loan amount sanctioned to borrowers is based on age, salary, educational qualifications, credit history and previous employment track record.

You can club the income of your spouse, in order to increase your loan eligibility. Typically, banks only lend the amount where your monthly EMI outflow is 30 to 50 percent of your salary. Any amount greater than this would make repayments towards the loan a burden and one may default.

What is EMI?

EMI stands for equated monthly installment. It comprises interest and principal components. EMI repayments commence when you take a full disbursement of the loan amount. Pending final disbursement, borrowers only pay interest on the amount disbursed. This is called the pre-EMI interest.

When a borrower makes EMI payments to the lender, during the initial years, a large chunk of money will flow towards interest repayment. As the years roll by, the principal component increases.

If you do not own a house of your own, it is time you consider taking a home loan. Borrowers can also avail tax benefits on both the principal and interest components of the loan. This makes it even more lucrative.

Options in home loans

Home loans usually come in three flavours - floating, fixed and hybrid. In case of a floating rate loan, the interest rate fluctuates with the prevailing market rates. It is usually pegged against the bank's prime lending rate.

This moves up or down depending on the movement of repo rates, inflation, cash reserve ratio and liquidity in the system. Exposed to a host of external factors, a floating rate of interest is simply unpredictable. But as much as 80 to 90 percent of the borrowers have opted for the floating rate.

Borrowers, who opt for the floating rate, intend to benefit from a fall in interest rates. If, on the contrary, the rates go up, they have to pay out more money in the form of EMI to the lender.

They understand that interest rate fluctuations follow a cyclic pattern and are further lured in by the lower cost of this loan. If you are taking a short-term loan, simply float. It is difficult to predict the interest rate scenario over a long term.

Pure fixed rate loans, as the name implies, remain fixed for the entire tenure of the loan. Such a product is offered by very few banks as interest rate on them is very high compared to floating rate loan. What most lenders offer is fixed rate loans - fixed for a short tenure, say five years. So the rate remains fixed for five years, after which the interest rate is reset to the value prevailing at that time.

Fixed rate is for borrowers who are anxious every time the rates climb up. Those who want predictability and want to set aside fixed money towards their loan repayment can select fixed loans. Such borrowers believe that the rates will travel northwards.

Before locking into a fixed rate, go through all the fine print to know how 'fixed' the product really is. If it comes with a reset clause, it means the bank can at its own discretion increase your rate, though it is called a fixed rate loan.

Between the fixed and floating rate option, investors have the hybrid loan alternative. It is a combination of fixed and floating rate loan, where a borrower can decide how much he intends to lock under fixed and how much he wants to expose to floating rates.

If you're unsure simply lock 50 percent of the loan under fixed and remaining under floating rate. This innovative product gives more flexibility and option to the borrower.

With interest rates giving all indications of going southwards, it is time to consider investing in a house. A home loan will help you realise your dream of owning a house.