India is a vast country, having a population of more than 1000 million. Many are without shelter of their own. After independence, the successive governments have addressed this problem with various government-sponsored programmers. They targeted the poorest of poor and houses with barest facilities were provided.
The problem was too gargantuan to be met by the government alone. The government of India established National Housing Bank, under the supervision of Reserve Bank of India. Scheduled Commercial Banks, Co-operative Banks, were also directed to lend for purchase/construction of houses. In the beginning 1.5% of incremental deposits of commercial banks were earmarked for housing finance sector during the year 1988, which was enhanced to 3% during the year 1999 and subsequent years. The banks were given freedom to exceed this stipulation depending upon their resources. The slow down of economy, slump in the demand for loans from corporate sector goaded banks to aggressively market housing loans. In course of time, banks have overtaken the housing finance companies in the market. The easy availability of finance, the tax benefits extended by the Union Government and increased earning/spending capacity of middle class, mostly wage earners, have fueled the growth of this important sector.
Change of Mindset
Owning a house, previously was the last priority, mostly at the time of retirement from out of the terminal benefits savings as one could rarely find the means of finance for the purchase/construction of house. This mindset is changed. Youngsters in early twenties are earning substantial salaries with increased spending capacity. They prefer to own houses out of borrowed funds which is repayable over a period of time. This helps them to avail of lower interest rates and also tax benefits for longer period.
The repaying capacity is the single determining factor. There must be regular monthly income with enough surplus to meet the monthly repayments. The maximum age limit is 55 years which may be extended to 60 years in deserving special cases. If the applicant is more than 50 years, any of the legal heirs may have to join as co-borrowers. Salaried person should have a confirmed job with at least minimum five years of balance service. Professionals like Advocates, Doctors, Engineers, Chartered Accountants, Company Secretaries etc, should have established income of at least three years. Retired persons / pensioners are generally not entertained to avail the Housing Finance. Further rental income can be added for eligibility for higher loan.
Legal Scrutiny Report and Valuation
It is very important to have legally established ownership of the property to avail of the Housing Finance. The applicant should have all the documents to establish his title to the property. He should verify the documents available with him/or with the seller and perfect the title to the property. Financing Institutions will rely on the legal scrutiny report of their advocates on panel. In view of the severe competition in the field, many institutions are ignoring the importance of the legal scrutiny and title to the property and are giving much importance to the repayment capacity
Apart from perfect title to the property, valuation of the property is also very important based on which the loan component will be determined. Banks have approved valuers on their panel who will value the property and arrive at the market value.
Many institutions have a maximum ceiling of one crore-per party. The loan depends upon the cost of construction, land purchase cost, stamp duty, registration charges, legal charges and also other additional expenses. The borrowers may have to bring in 10 to 15% of the cost as margin money. There are institutions which finance full cost without insisting on margin money. In addition to these parameters, the income of the applicant, repaying capacity of all the borrowers are considered.
The loan is to be repaid in monthly instalments comprising of interest and principle called equated monthly instalments (EMI). The amount of repayment remains the same during the entire tenure of the loan.
In case of construction, the loan amount is disbursed in instalments depending upon the progress of construction. The regular repayment commences after the completion of construction or after expiry of certain stipulated time. Interest for intervening period from the date of loan to the commencement of equated monthly installment is called pre-EMI. This has to be paid quarterly or monthly.
Though repayments offered vary upto a maximum of 20 years, it is preferable to avail of the period of 10-15 years considering the interest rates, tax benefits and repayment capacity. The repayment period of 5 years attract heavy monthly instalments, which prove to be burdensome; in repayment beyond 15 years, one has to pay heavy interest. There are institutions, which offer repayment period beyond 20 years also.
Certain banks have special schemes under which any surplus amount available may be paid in excess of equated monthly instalment with facility to with draw such amount in case of necessity. The account operates like a current/over draft account. This would be useful for business people. Such schemes are called Home Loan Saving Schemes where by paying off the loan early substantial amount of interest is saved.
Recently, the repayment has become flexible to suit the borrowers. Step up payment is useful to young borrowers where EMI in the beginning is small which increases as the income of the borrower grows. Step down payment is useful for aged borrowers where EMI will be more during the beginning and goes on reducing as the income diminishes.
At present loans are available at 9 % interest. There are two different types of interest rates floating and fixed.
Here the rates are not constant, but keep on changing. These are linked to the market conditions. They may increase or decrease. The lending institutions are very reluctant to pass on the benefits of reduced interest rates to borrowers. They adopt different strategy to keep the borrowers paying higher rates. In most of the case the old borrowers pay higher rate than a new borrower for a similar loan.
This is supposed to remain fixed through out the tenure of the loan. Fixed rates are higher than floating rates but many banks/housing finance companies have "Force Majeure" clause in their agreement, which gives absolute powers to change the fixed rates of interest also.
In general, the fixed rates for loans of long tenure, floating rates for loans of short tenure may be preferred.
Many offer a combination of both fixed and floating, where some percentage is charged as fixed and balance as floating.
Reducing balance means the period at which the installments collected from borrowers are credited to the loan account. In annual reducing balances the monthly instalments collected are credited to the loan account once in a year. In monthly reducing balance they are credited on a particular day of month and in daily reducing balance, it is credited on the same day. Annual reducing balance is mostly costly, where as daily reducing is the best. Many have monthly reducing balance and few have daily reducing balance.
There is no transparency in Housing Finance Sector. Apart from interest the borrower has to pay processing charges, legal fee and many other types of fees, such as administration fee, inspection fee, etc. Further the rates at which these are charged are also not clear. In view of this, though the interest rates are low, the hidden costs increase the burden of the borrower.
The borrowers have an option of switching over from floating/fixed to other mode upon payment of certain penalty. Generally it is 1% of the outstanding loan amount. But recently, the financing institutions have increased fee for switching over. While switching over, consider the penalty payable, the loan balance, the rate of interest available and the remaining repayment period. If the remaining repayment period is short it is not advisable to switch over.
Transfer of Loans
The borrowers may also transfer the loan to other institutions which take over the loans. Many borrowers transfer the loans to avail the reduced interest rates available. The interest rates during 1990-2000 were very high. In case of transfer of loan, the borrower has to pay some prescribed fee calculated on the outstanding loan. Apart from such fees, the institution, which takes over the loan charges processing fee, legal charges etc. They may offer some additional loan also. But avail of such additional loan only in case of absolute need. While transferring the loan apart from interest rate, calculate the transfer fee, processing/legal fee and mode of reducing balance adopted by the institution which takes over the loan and hidden costs. If the balance repayment period is small, transfer is not recommended.
Home loan borrowers have two types of income tax benefits:
1. Rebate on repayment of principal and stamp duty and registration charges.
2. Deduction of Interest
The Stamp duty and registration charges paid and repayment of principal is eligible of rebate on a maximum amount of Rs. 20,000/- within a over all limit of Rs. 70,000 under section 88 of income tax act 1961.
The interest paid in a financial year on housing loan is allowed as deduction under section 24 of the income tax act 1961. The maximum interest allowed at deduction at present is 1.5 lakhs in case of self-occupied house. This is per individual. If there are more than one borrower, with definite shares in property, each may avail of this deduction, subject to his share, with a maximum ceiling of 1.50 lakhs. There is no such ceiling in case of properties, which are let out. Any amount of interest paid on the loan is allowed as deduction, and the income from the property by way of rent is taxable.
Apart from insurance of property against fire, riot, civil commotion, many insurance companies offer term policies on payment of single premium. These term policies cover risk for certain period and repay the loan in case of any loss of life of borrower.
Selection of Financier
Housing finance is most easily available credit product. All the commercial schedule banks, co-operative banks extend finance for purchase/construction of houses. In addition there are housing finance companies specialised in this line. Many of these institutions are concentrated in metro and urban centres. There is severe competition. In general the rates of interest in housing finance companies are slightly higher than banks. Though there is intense competition, there is no transparency in Housing Finance industry. It is better to interact with different lending institutions and select the best. If one is a regular customer of any bank, it would be better to borrow from such a bank.
While selecting the Financing Institutions, examine the rate of interest, charges for shifting, hidden charges, transparency and accessibility to the financing institutions. Many institutions operate through direct selling agents and the borrowers will rarely have a chance to interact with the officials of the institutions. Further there is very little for selection between any two institutions.