Not all of us are informed and aware of the terms that are used in a home loan or how a home loan will affect our lives in the future. People who are not from a finance background may not even understand some of the most basic home loan terms used in India. (So, if you are one of those who know about Home Loans and how it works, this article may not be for you )
Keeping that in mind, we bring to you lesson 101 in home loans and 4 key terms that go with it. These key terms have been explained in a simple manner without the use of technical jargon, just the way you like it!
EMI or equated monthly installment is the amount of repayment that you will have to make to your lender every month. You should also know that an EMI is made up of:
- Principal amount portion
- Interest portion
The % of the principle amount and the interest amount in your EMI will vary over the life of a loan. As a borrower, you can request a breakup of the same from your bank to get an idea of how much interest you will be paying as the years go by.
As the borrower of a home loan in India, what you need to be aware of, is to make conscious provision for EMIs in your monthly budget. For example, let’s consider you take a home loan with an EMI of Rs. 20,000. Your monthly salary is Rs. 40,000. Your household comprises yourself and your wife, a caring homemaker. The EMI may seem affordable to you right now, but what about the time when you have kids in the future? Will the increase in your salary be competent enough to meet the increase in expenses?
As a general rule of thumb, an EMI which is 30% or less of your total income is acceptable when it comes to budgeting and forecasting cash requirements for your personal financial position.
As scary as the word ‘Down Payment of a home loan’ sounds, it is actually the opposite. A down payment will be your best friend when it comes to reducing the EMI which will be a bore on your pocket in the future. Essentially, a down payment is the amount of cash your will pay for your home from your pocket.
Generally, banks fund up to 80% of the value of a home. In simply words, if you are going to buy a home worth Rs. 30 lakh, the bank will fund 80% or Rs. 24 lakh. This makes your down payment a whopping Rs. 6 lakh.
As a borrower of a home loan, you need to know that higher the down payment, the lesser the burden of EMI and debt on your shoulders over the life of the loan. In the above scenario, if you had made a down payment of Rs. 10 lakh, your EMI would have been significantly lower.
The most recommended way to achieve this is through savings. Yes, there are banks and institutions who offer loans or credit facilities for the down payment itself. Some common ways and means to raise debt for the down payment are getting loans on jewellery, breaking fixed investments, asking the builder for financial help or availing loans from employers. However, raising debt for repaying another debt is best avoided on a personal level.
Pre-payment of a home loan occurs when you as a borrower decide to reduce the borrowed principal by making a lump sum capital repayment. For example, a borrower takes out a housing loan of Rs. 24 lakh (continuing the above example). 2 years later, the borrower has a windfall gain from the stock market of Rs. 5 lakh. Being wise, the borrower contacts the bank and makes a lump sum capital repayment to reduce the outstanding amount of the loan. The very obvious benefits of making a pre-payment are that the borrower will have lesser debt and reduced EMI over the life of the loan.
As a borrower, if you are thinking of making a pre-payment, you should confirm with your bank if there are any applicable fees or charges if you prepay. If there are charges, generally known as a ‘pre-payment charge’, you may want to consider cost vs. benefit in terms of the fees vs. reduction in EMI.
Fixed rate vs. Floating rate
A fixed rate home loan means that if you have availed a housing loan for x%, the rate of interest charged on the loan will be x% for life. On the other hand, if you have a floating rate home loan, the rate of interest may be charged at RBI base rate / other benchmark rates + x%, or according to your bank’s own benchmark rates.
Prima facie, it is difficult to comment on which is better without going through the individual circumstances and the financial position of the borrower, the amount of loan and the repayment structure.
As a borrower, you may want to make an intelligent decision whether to opt for a fixed rate home loan or a floating rate home loan. If the current economic situation is such that lending rates are at their lowest in many years, you may want to consider a fixed rate to avail the benefit of the low rates even when they go up in the future.
So there you have it basic dope on Home Loans in India.