Home loan: track all these factors before you go for loan

Use Mortgage as an Overdraft Account

This is one of the least used options available in the market. Outside India, the product is generally called as an Offset mortgage. In India, the product is sold by State Bank of India by the name Max Gain.  In this type of mortgage account, if you have surplus funds, you can deposit the funds in your bank / mortgage account and interest shall be computed on the balance mortgage loan. You are free to withdraw the deposit and the interest shall levied on the remaining balance. Hence, when ever you have surplus funds, you reduce your interest payouts. If you find an investment opportunity, you can withdraw the funds from your mortgage to fund your investments. By this way, you tend to get a good mix of putting surplus funds into work (by reducing interest payouts) and at the same time having the flexibility to get the funds back when needed. It is important to note that any deposits made in such an account do not end up reducing your mortgage balance permanently. The excess funds temporarily suspend interest accruals on the deposited amount till such a time these funds are not withdrawn by the account holder.

 

Debt Equity Ratio – This is one of the classic financial ratios and perhaps one of the first ratios looked into by analysts to identify how risky a financial decision is and hence determining the respective financing cost (interest rate). It works opposite to the Leverage example above. While leveraging mentions that the more your loan is, the better would be your net returns. However, the contrary aspect associated with it is – the more loan you have (in % terms), the more risky your investment become to the lenders. For example

John has a property valued Rs. 10 lacs of which only 1 lac has been paid by John from his pocket and remaining 9 lac (90%)has been taken on loan. John hence has a debt equity of 9:1.

Peter has a property valued Rs. 10 lac of which his contribution is Rs. 3 lac and remaining 7 lacs (70%)  has been financed via a loan. Peter has a debt equity of 7:3

If for examples real estate markets tank by 10% and the properties are now valued at 9 lac each, John's stake would be reduced to zero and Peter's stake would be reduced to Rs. 2 lac. If you are a financer giving a loan to John / Peter, you would rather want to avoid financing John as he is heavily leveraged and hence a more risky investor than Peter. In this example, John may walk away as he would not have any incentive to hold his property (considering it is less than the value he purchased and his entire investment has been wiped out). On the contrary, Peter would still be inclined to hold on to the property considering he has still 2 lacs of this investment in the property. Hence, even if the bank would want to finance John, they would charge a higher interest rate for the extra risk in that decision.

The reason why I explained the above – you may want to prepay your home loan to bring it within a comfortable debt equity ratio. Ideally this ratio is 7:3 to 8:2 i.e. Loan to Value of your property is 70%-80%. You may want to go even higher at 60%, but from there you start to  adversely affect your leverage ratio. Banks in many cases provide a better interest rate deal (specially outside India) if the Loan to Value is greater 80% or lower.

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"HSBC home loan customers have the option to make multiple part prepayment through the year," said Says Manish Sinha, head (consumer assets), HSBC India. "There is no upper limit on the number of times they wish to prepay. There is no minimum amount restriction for making any such part prepayment."

Banks including State Bank of India (SBI) and Axis Bank Ltd do not have restrictions. Some banks have a lock-in period after which you can start prepaying. For example, Kotak Mahindra Bank Ltd allows you to pre-pay after a lock-in period of six months.

A few banks allow you to part pay only few times a year. For instance, as per IDBI Bank Ltd's website, they allow part prepayment four times a year.

Is there a cost?

Last year, the National Housing Board had directed all housing finance companies to do away with prepayment penalties for loans with floating rates. In fact, even the Reserve Bank of India in its annual policy announcement for 2012-2013 directed banks to not levy any prepayment charges for home loans taken on floating rate. Detailed guidelines in this regard are expected soon.

In fact, some lenders, including SBI and Axis Bank, have waived such prepayment charges. "You will have to bear a small charge to set an electronic clearing service or standard instructions charges," said Siddharth Gupta, co-founder, GNBindia.com, a group buying portal for loans. "Most major banks will not charge any other transaction charge."

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If the high interest rate on home loan is giving you sleepless nights, it may be time to de-stress. While you decide whether to break that big fixed deposit to pay off a part of the loan - this has become easy now with mostbanks and housing finance companies , or HFCs, not levying pre-payment penalty - there is another option you can look at.

A number of banks and HFCs reduce the interest rate on floating rate loans for a fee. There is also the option of shifting the loan account to a lender offering a lower rate.

NATURE OF LOAN SCHEMES
You can get the rate reset at a lower level if you are being charged more than what new customers are paying. While some banks charge 25-50 basis points, or bps, of the outstanding loan amount for this, many calculate the fee on the basis of the difference between the rate you are paying and the market rate.

"We charge half a percent if the difference between the rate charged and the market rate is half percent and one percent if the difference is 2-3 per cent. So, it depends from customer to customer," says Jairam Sridharan, senior vice president and head of consumer lending and payments, Axis Bank.

HDFC charges half the difference between your home loan rate and the market rate. For example, if a customer is being charged 12.5 per cent and the rate for new customers is 10.5 per cent, HDFC will charge 1 per cent. It is a one-time payment. "The lender, however, retains the right to reject a reset request," says Sumit Bali, executive vice president, Kotak Bank.

Banks may refuse to reset the rate for customers with a history of default. "We check the customer's credit score. If there is a drastic change, say the person now comes in the distressed profile category, we may not cut the rate. But this is done only if the person's credit score has changed drastically," says Sridharan of Axis Bank.

AFTER CONVERSION
While the paperwork is minimal, the new rate, too, is subject to changes. For example, if the Reserve Bank of India, or RBI, raises policy rates, banks will in all likelihood pass on that to you. However, a rate cut will bring benefits. In short, the new rate will also be floating.

LOAN BALANCE TRANSFER
Since many banks now do not charge pre-payment penalty , one can think of transferring the loan to another bank. However, for this, you must take into consideration things such as processing fee payable to the new bank.

Many banks charge 0.5 per cent of the loan amount as processing fee, while some charge a flat Rs 5,000-10,000. Transferring a loan will also involve a lot of documentation.

Before going for loan transfer, you should look at the ability of the bank to reduce rates in a falling rate scenario. This is because some banks increase rates as soon as the RBI raises rates but are slow in passing on the benefit of any rate cut to customers.

Another important consideration is transfer of your documents. There have been cases of lending institutions losing the original documents. While many banks and HFCs take utmost care in taking delivery of your original home documents from your previous lender, any failure can cost you your original property documents.

Ref:

http://www.businesstoday.in/moneytoday/banking/home-loan-rate-outstanding-payment-bank-fees-lower-rate/story/22664.html

http://insight.banyanfa.com/home-loan-prepayment/

http://www.hindustantimes.com/india/home-loan-prepayment-helps/story-kR7BWMUaejOkNQVyuHGHFM.html

Also read:

http://www.businesstoday.in/moneytoday/banking/rbi-ends-penalty-on-loan-pre-payment-should-you-switch-banks/story/184728.html

http://www.moneycontrol.com/news/home-loan/should-you-use-your-surplus-funds-to-prepay-home-loan_1058921.html

Comments

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