A Borrower’s Checklist: How To Select A Home Loan

If home loan rates are any indicator, this is probably the best time to buy a house in India. Home loan interest rates are at 15-year lows, with some lenders offering home loans at less than 7%. If you factor in the tax benefits on the interest paid, the effective cost of the loan in higher tax slabs works out to less than 5%.

A home loan is a long-term financial commitment spread over a time span of 15-20 years and one misstep could cost you both money and peace of mind. If you plan to buy a house with the help of a loan, choosing the right lender and the most appropriate loan options are strategic decisions. 

Here is a guide for when you go shopping for a home loan.

Things To Know Before Selecting Your Home Loan

As a first step, understand the various aspects of the loan. The aggregate cost of the loan will depend on your loan tenure and the ancillary services. Important variables to focus on are as follows: 

Rate of Interest

The interest is factored into the equated monthly instalment (EMI) along with the principal component. The interest is charged on a reducing balance basis, which means the principal outstanding comes down with each EMI payment.

Currently, home loan rates of interest are as low as 6.65% per annum. Women borrowers are offered a 0.05% discount, so it makes sense to take a joint home loan with a woman as a co-borrower. 

At the above rates of interest, the estimated EMIs for different tenures work out as below.

Maximum Loan Amount

The maximum amount one can borrow for a house is governed by two attributes: the value of the property and your income level. Banks usually fund around 70-75% of the value of the property, though some aggressive lenders can go up to 80% as well. 

There is another consideration here: your repayment capacity. Before extending credit, the bank will assess your current cash inflow and existing liabilities, thereby determining your monthly repayment capabilities. 

Unless there are extraordinary considerations, it is advisable to limit home loan EMIs within 40% of your net household income. 

Processing Charges

These are charges for processing the loan application and the expenses incurred by the bank on assessing property value and on verifying other details mentioned by the borrower. The charges vary across lenders, and can be between 0.25% and 1% of the borrowed amount for self-employed borrowers. For the salaried, the charges are much lower ranging from INR 2,000 to INR 10,000. 

There is always scope for negotiation with your lender. 

Prepayment Charges

The central banking authority, the Reserve Bank of India (RBI), does not permit banks and housing finance companies to levy prepayment charges on floating-rate home loans, but in case of fixed-rate home loans, they can impose pre-payment penalties. 

In the course of your loan tenure, your cash surpluses could be utilised towards full or partial prepayment of your outstanding loan. It is, therefore, important to minimise or totally eliminate any future expenses on pre-payments.

Pre-approved Loan Quote

Searching for a property can take weeks, if not months. Before you finalize a property, it is a good idea to arm yourself with a pre-approved home loan. 

To get a pre-approved loan, your loan application will be assessed on the basis of your income and repayment capacity. Once the bank has completed this exercise, you will receive an in-principle loan approval. Now, only the property value and its legal ownership remain to be verified. 

This activity is useful as it’ll help you establish greater clarity regarding the purchase budget and you can confidently make the right selection for yourself.

What the Market Has On Offer

To understand what’s on offer, you could visit the websites of individual lenders, but collecting and comparing information on interest rates, allied charges and other terms and conditions can be rather cumbersome. 

You could visit a loan aggregator website to compare different charges, rates of interest, loan amount, and other terms and conditions applicable on your loan requirement. While aggregators help with relevant information at one place, seeking professional advice is recommended. 

Be careful not to initiate multiple home loan enquiries as it may adversely impact your creditworthiness. Loan enquiries are reported to the credit bureaus for verification of the individual’s credit score. Too many enquiries imply that the person is credit hungry and could dent your credit score.

Steps to Choose A Home Loan

When applying for a home loan, you need to make a choice between your rate of interest, the tenure of your loan, as well as external factors such as the goodwill of your lender. Here are some steps you can take: 

Choose between Fixed and Floating Rates

This is a no-brainer when interest rates are elevated. Ten years ago, home loan rates were hovering around 9.75%. The EMI of a 20-year loan was INR 9,485 per INR 10 lakh. In such a situation, a floating rate loan was invariably the better choice. 

When interest rates are low, choosing a floating rate loan would mean you may have to pay more interest whenever rates go up. Currently, home loan interest rates are low, around 6.65%, and the EMI per INR 10 lakh for 20 years is INR 7,544. A further cut does not seem probable. 

Another factor to consider is, fixed-rate loans are up to 0.75% to 2% higher than floating rate loans. For example, HDFC Limited charges 6.7% for a regular floating-rate home loan, but its fixed-rate loan is priced at 7.45%. For the borrower, it’s a choice between a costlier loan that remains constant for the rest of the term and a cheaper one that could go up when rates rise.

Given the current scenario, a fixed-rate home loan that locks-in the prevailing low rates could prove advantageous. It’s a good idea to lock a low rate for the next 15-20 years, thus ensuring constant EMIs even with increasing rates of interest.

Check External Benchmark  

Indian borrowers often complain of banks not reducing home loan rates despite lowering interest rates. Taking cognisance of this, the RBI recently mandated external benchmarking of loans, thereby removing opaqueness in pricing of loans and ensuring that benefits of falling rates are duly passed on to the borrowers. 

Most banks have chosen to link their loan rates to the repo rate, which is the rate at which the RBI lends to banks. 

It is advisable to go for a bank that has selected the repo rate as its external benchmark because it is stable and does not change frequently. Moreover, while other benchmarks are market-driven, the repo rate is driven by the regulator.

Opt for Optimal Loan Tenure

While choosing the most suitable lender is important, it is equally crucial to select the most appropriate tenure for your loan. A longer tenure reduces the EMI and is therefore easier on the pocket, but the interest outgo is high. On the other hand, a shorter tenure will mean higher EMIs, but could prove to be unaffordable.

Let’s understand how tenure affects interest outgo on a loan of INR 50 lakh at 6.65% as the rate of interest: 

Can Choose Longer Tenure: When applying for a home loan, one should ideally go for the longest available tenure, that is, 15-20 years, as a relatively longer tenure will yield the highest loan amount. As the years roll by, cash inflows generally increase and one can then decide to prepay, either partially or completely. Thus, reducing aggregate interest outgo.

Can Opt for an Overdraft Account: A loan account that functions as an overdraft is another way to minimise interest cost. An overdraft loan account carries a marginally higher rate of interest when compared with a pure home loan. 

This facility best suits those who generate surplus funds sporadically and the available excess cash then resides in the loan account. Since interest is charged only on outstanding balances, this culminates in considerable savings in overall interest cost as compared with the vanilla home loan. The borrower has access to the funds in the overdraft account whenever needed. 

Take Insurance Cover

Lenders have an interest in the asset and therefore insist on property insurance. By simply paying an insurance premium as low as INR 2,000 per year, you can protect your home worth INR 50 lakh against losses due to natural causes such as an unexpected fire or unforeseen calamities like floods and earthquakes. Such policies usually cover only the structure, but can be extended to cover the contents of the house as well depending on your insurance terms and conditions.

Similarly, it is in the interest of the borrower to cover the risk of an outstanding loan liability. To guard against a possible unfortunate turn of events, it is recommended that the borrower purchases a term insurance to protect his family against banking dues. Most banks and housing finance companies include the insurance premium in the home loan amount. One can also independently purchase a policy. 

Look Beyond Financial Aspects

Apart from choosing a low rate and most suitable terms, one should prefer a lender that offers superior post-disbursal service and is more responsive to customer requirements.

During the long period of a home loan tenure, the borrower will be required to interact with the lender on multiple issues. For instance, when rates change, some lenders proactively inform borrowers about the changes and offer guidance on how to make most of the new terms.  However, some lenders do not keep the borrowers in the loop and the borrower is left to decipher the changes on their own.

Accessibility is another key factor. A lender should be easily accessible to the borrower and flexible enough to make changes in the loan schedule. Do thorough online research and look up customer reviews of lenders before closing your loan. Reach out to friends and acquaintances and factor-in their experiences before you finally decide on your lender.