18 April , 2021 19:12 IST
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Getting your Home and Hearth on a Loan

Author: P V Subramanyam

Very few of us may have the option of staying on in a parental house for the rest of our lives. For whatever reasons, we may have to buy a house at some stage of our life. So like all middle class persons, when we have to buy a house, we turn to a housing finance company – increasingly banks.

When we do buy or contemplate buying a house, the following questions arise. Let us list a few of these questions.

Should I buy a house?

This is perhaps the most difficult question to answer. Let us ask ourselves unemotionally – do we need a house to live in? The answer is yes. But do we need to own it? The answer is not so obvious. If you can get to live in a house costing Rs. 30 lakhs paying a paltry Rs. 80,000 as rent why should you buy? However a house is not such a clear financial decision. It is an emotional one – everyone around you is buying, it is considered to be a form of ‘security’, you need to have one address for all your legal requirements, etc. However purely from a commercial sense, it makes sense to rent rather than borrow.

Once you have decided to buy a house, and that too funded by borrowing, the following questions will arise.

How much should I borrow?

A classic question for which none of us have a clear answer! The norms that banks use these days is that EMI should be less than 60% of net income. Though this sounds all right on paper, the final answer should be tailor-made for each individual. If you are earning Rs. 400,000 per annum and your EMI is Rs. 20,000, how will you pay your taxes and what will you eat? However, if your annual income is Rs. 25,00,000 you can perhaps comfortably repay Rs. 15,00,000 on an annual basis. However, even with the current softening of real estate prices, banks have not really softened their criteria. They still look at 60% of current income.

Ideally you should see how many years’ efforts you are willing to put in a house. So if you are earning Rs. 500,000 a year and you buy a house for Rs. 25,00,000 you are saying, I am willing to spend 10 years of my GROSS income for a house.

How much is the cost of my house?

If you read this question twice, I cannot blame you. The cost of a house is not what the broker told you is the cost of the house, but the EMI that you pay multiplied by the period of the loan. Thus if the ‘cost’ of your house is Rs. 25 lakhs, and your loan is Rs. 25,00,000 then the cost of your house would be Rs. 27,000 (EMI) x 12 months x 20 years. And that works out to Rs 64, 80,000. Thus the cost of your house is, well…err… about Rs. 65 lakhs.

Should I take a floating rate or a fixed rate?

Currently it looks like floating rate is a good choice. However, very few people can give a correct directional call on interest rates, so your guess is as good as mine.

I had taken a loan of Rs 7 lakh in 2005. Now my EMI has increased. Can you suggest a solution?

There are 3 possible solutions now that you can consider – repay a part of the loan by withdrawing from your provident fund or PPF. This will reduce the amount of the loan and thus the EMI.

The other solution that you could consider increasing the tenor – especially if you are young. If, for example, you are 30 years of age and your loan is for 20 years, you could increase the tenor to say 25 years. This will also reduce the EMI, however your total interest costs will go up.

Pay the increased EMI and use one time cash flows like Diwali bonus or annual bonus to prepay part of the loan. This will also help you in reducing the EMI.

Are there loans which take into account my increasing income while considering my eligibility?

There are some loans called telescopic loans – it starts with a small EMI and as your income increases, the EMI also increases. This makes sense in a growing economy, but only people with good qualifications and in growth industries should consider this option. What you are actually asking is do banks take your current income or your prospects – traditionally bankers like to see a track record of cash flows.

What is the maximum tenure that I should borrow for?

You should borrow for the minimum period in which you can repay the loan. The longer the tenure, the higher the interest rates. However a longer term loan will look cheaper because the EMI is lesser for a longer period.

The period for which you borrow is also a function of one’s age. If you are 30 years of age, you can hope to get a loan for say 25 years. However if you are already 44 years of age, you will get a loan only for 16 years – assuming that your retirement age is 60 years of age.

Most banks are comfortable with a loan tenor of 20 years, but in some young borrowers the bank will consider a repayment period beyond 20 years also.

I have a house, and last year I pre-paid all my home loans. I had taken a loan of Rs. 11 lakhs from HDFC. Now they are offering me a new loan of Rs. 28 lakhs. Should I use this to buy a new house?

Congratulations! You are a delight to a housing finance company! You had paid processing fees and such one time charges, and still pre-paid your loan. Now you will pay all these charges once more, welcome.

You should not buy a house just because you are eligible to avail of a loan. You should buy a house either for living, or as an investment. If it is an investment, check all options like what the returns will be in the form of rent and appreciation.

Though it may be difficult to predict, over the past few years, commercial properties have given better returns.

My friend was telling me I should take a life insurance cover for at least the amount of loan that I am contracting. Is it necessary?

Absolutely correct. At your current level of income and assets accumulated, you think you are adequately insured. However, if you contract a new liability, your life insurance cover WILL have to be revisited.

Author is a Financial Domain Trainer

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