How to choose a Home Loan Provider
Here are some factors that can help you evaluate a lender:
Total financing cost. Choose a financier who gives you the lowest total financing cost, which takes into account the interest cost and other upfront costs incurred while applying for a loan.
Exploit existing relationship. Explore the possibility of obtaining a loan from your current financier or banker first. It is easier to get a loan here because he already knows your credit history and you can use your relationship to extract better terms.
Extent of financing. Choose a lender who provides you the highest possible loan amount, so that the down payment is reduced.
Other services. Look for a lender who can offer value-added service, such as property service for home loans. Some lenders, particularly banks, offer free credit cards, bank accounts or even free demat accounts. Don’t, however, choose a lender based purely on the freebies offered.
Network. Look for a lender with a wide branch network.
Doorstep service. Check if the lender will collect all the documents from your home, and check if this service is free.
Ease of processing. Try and select a lender who makes the loan process easy.
Collateral. As a rule, you don’t need to provide an extra collateral in case the asset you are buying from the loan proceeds is hypothecated to the lender.
Flexibility in repayment options. Check if the lender will customize the repayment plan.
Income heads. Check if a lender considers all your income or whether he excludes a few income heads when calculating your loan eligibility.
How to pre qualify for a loan
A pre approval is an informal agreement with your lender. The lender forms an opinion on your repayment capacity based on income details you have provided to him. If he finds you creditworthy, he issues a letter giving an in-principle approval for the loan.
A pre approval is recommended if you want a loan but have not yet identified a property. Not only does it put your mind at ease while you search for your new home, it also makes the loan disbursal process far less time-consuming. You will also be in a stronger negotiating position with the seller.
- Pre approval depends on your repayment capacity, which is based on your current and expected income. Your spouse's income can be included to enhance the loan amount.
- You need to indicate that you have not yet identified the property.
- You have to fill in the application form.
- You need to pay a processing fee or administrative charge. This is usually in two tranches: one, on submission of the application form and, two, on actual disbursement of loan amount. In case of pre approval, you need to pay only the first tranche. If the processing fee is charged at one shot at the time of application, it will be adjusted after the property is identified.
- The lender will then conduct a credit evaluation and an interview.
Points to note
- A pre approval is valid for a year. This can be extended by a few months at extra cost at the discretion of the lender.
- The pre approval is not binding on the lender; he can refuse the loan if he does not approve of a property. Therefore, ensure that the title to the property is clear, marketable and free from encumbrance. Check with the lender before committing to buy.
- You are under no obligation to this lender if you find a better deal later. But in such a case, you will lose the processing fee.
How to enhance your loan eligibility
A little homework on your part can make your loan application a loan officer’s delight.
- Offer a clear bank statement without any cheque returns.
- A bank account that shows monthly deposits enhances your loan chances.
- Pay off outstanding loans before you approach a new lender.
- Co-applicants and guarantors enhance loan eligibility.
- If you have a clean credit history on your credit card or on a previous loan, your chances improve. Approaching your credit card issuer or previous lender is your best bet.
- Mention any previous loans you might have taken from the lender for a possible discount on interest rate.
- If it is a housing loan, ensure a clear title deed.
- Try and provide supporting documents for every entry on the application form.
If you're self-employed
Credit assessment is likely to be more stringent if you are self-employed. Keep these points in mind:
- File your income-tax return on time. Lenders scrutinize IT returns closely. Do not apply for a loan immediately after filing your returns, as this could give the impression that you have done so just for the loan.
- Audited accounts are preferable. The lender is essentially looking for verifiable and clear sources of income.
- The lesser the component of irregular and other income, the better. Inclusion of irregular interest, dividend income or capital gains on sale of assets is discretionary on the part of the loan officer.
- Highlight any credit line, even if it is from another lender. It shows the confidence reposed on you by another banker.
- Ensure that your loan payments do not exceed 40 per cent of your income.
- Don’t understate depreciation. Lenders add back items such as depreciation which do not result in any cash outflow to the company. Thus, the greater the depreciation, the greater will be the cash profit considered for loan calculation.
- Sustained business growth enhances your loan chances.
- A steady clientele and good credit terms with your suppliers will improve your chances.
- Free assets (those that are not pledged as collateral) that can be pledged strengthens your loan chances. If yours is a proprietary firm, you may be asked to mortgage your personal assets.
- Ploughing profits back enhances your chances of a business loan.
- Inform your lender of any awards or recognition that your products/organization might have won.
If you're salaried
Loan amounts for salaried individuals are calculated on the basis of the monthly salary, but most lenders ensure that your loan installment does not cross 40 per cent of your monthly income.
- If your income is insufficient, you could add a co-applicant. Make sure your co-applicant's income is from acceptable sources.
- If there is an existing loan, or deduction towards payment of advance from your employer, your net salary will come down, affecting your loan capacity.
- Your loan eligibility may be enhanced if you can show other regular sources of income besides salary, such as rental income or dividends.
- Proof of accumulated savings in the form of PF, FD or long-term investment in shares will improve your chances.
How to fund home improvement
Anything that significantly enhances the value of the house can be funded. Lenders will fund external repairs, water proofing, roof repairing, plumbing and electrical work, painting the house, adding grills, tiling and flooring. Here are some factors to be considered before applying for a loan to fund repairs:
Home improvement loans. The loan amount is generally 50-70 per cent of the cost of the improvement, subject to a maximum of Rs 20 lakh. The loan is available for up to 10 years. Repayment should ordinarily not extend beyond retirement age if you are a salaried employee, or beyond 65 years of age if you are self-employed. Most lenders expect the property to be mortgaged, though some extend unsecured loans with two or three guarantors.
Tax benefits. You are eligible for tax benefits when you undertake repairs to your home. The interest on capital borrowed to repair or reconstruct a house is allowed as a deduction. Also, the brokerage or commission to get the loan is allowed as a deduction. You can claim one-fourth of the net annual value as a deduction towards repairs, irrespective of the actual expenditure incurred.
How to apply
- Decide what kind of repairs you want to carry out. You could consult an architect or a structural engineer.
- Extensions and further construction require clearances from municipal authorities, and are required to be produced for the loan.
- Initiate the loan process after you have identified a contractor to carry out the work and received an estimate of how much the repairs will cost.
- If the repairs are staggered, lenders link the disbursal amount to the progress of the repair work.
- Secure the disbursement of the loan after you complete all the legal documents and put in your own contribution. Loan disbursement can be made in full or in installments depending on the progress of repairs. Interest will be calculated on the actual draw-down of the loan.
- You can bring in an earning member as co-applicant to increase your loan eligibility. A co-applicant need not be a co-owner in the property.
- Title deeds for a period of at least 13 years
- Encumbrance certificate for the past 13 years.
- Khata certificate (basic document indicating ownership of property as entered in the register of the government authorities).
- Up-to-date tax receipts of the property.
- Sanctioned plan and license for the extension.
- Estimates of costs from a qualified engineer.
- A cost estimate from your architect or contractors
How to get an equity loan
Some banks and finance companies offer loans in the form of overdraft facility against financial securities such as shares/units/bonds. The lender will charge interest only for the number of days you've utilized the loan and that too only on the amount utilized out of the amount sanctioned. Keep the following points in mind while pledging securities:
Determine what stocks you can pledge
Only fully paid-up shares that figure on the lender’s approved list of securities are accepted. The approved list usually contains actively traded and liquid stocks. Usually, a maximum of 20 shares can be pledged.
Some lenders accept physical shares only in market lots, so pledge only market lot securities or convert odd lots into demat. Most lenders prefer demat shares, and these shares are eligible for a higher loan amount and are often charged lower interest.
Lenders advance against mutual funds units as well, although the extent of lending is lower.
You can pledge shares belonging to you as well as relatives. Here is the list of close relatives whose securities can be considered for pledging:
- Children (above 18 years of age)
- Grandchildren (above 18 years of age)
Lenders normally do not accept shares held in the name of minors, Hindu Undivided Families, NRIs and companies. In case you are pledging shares owned by others, get a letter of continuity signed by other shareholders, signifying their consent to pledging of shares.
Determine your loan amount
Limits on funding. Your loan amount depends on two things. One, the extent of funding on a particular stock and two, the base price or the price considered by the lender for calculating the value of the shares. Lenders can extend loans up to Rs 20 lakh. You can obtain overdraft from Rs 25,000 to a maximum of Rs 10 lakh in physical shares and Rs 20 lakh in demat. These limits vary, as lenders are free to set their own conditions regarding the loan amount against physical shares, demat shares and number of scrips acceptable in one account.
Lenders can lend up to 75 per cent of the value of demat shares and 50 per cent of the value of physical shares, as per Reserve Bank Of India (RBI) guidelines. But lenders set their own funding limits, which are generally lower than the maximum limits set by the RBI. The extent of funding against mutual funds is generally lower at 40-50 per cent of the base NAV. The base NAV for mutual funds could be the last closing NAV or previous week’s average.
Find base price. Besides setting funding limits, banks have the discretion to price shares on any base price for calculating your portfolio and thus your loan amount. This base price depends on market volatility and the general direction of the market. It could be either the last traded price or the moving average of the last seven or ten days or a more complex average. The base price could differ from the current market price.
Your loan amount is calculated by multiplying the base price of a stock with the quantity of shares being pledged and the extent of funding on the particular stock. Say, 100 Infosys demat shares are to be pledged and the bank offers 60 per cent funding against Infosys demat shares. If Infosys’s base rate, as calculated by the bank, is Rs 7,450, the loan amount would be 60 per cent of (100 x 7,450) or Rs 4,47,000.
Evaluate lenders on costs
Interest charged by the lender ranges from 14 per cent to 18 per cent per annum. Interest is calculated on a daily outstanding balance and charged only for the amount and period during which you utilize the funds. Besides the interest rate, you have to pay a processing fee, which is 0.52 per cent of the sanctioned loan amount.
Other factors. Two important factors to consider when evaluating your lender are how often he reviews your portfolio and how much time he gives you to meet any shortfall. The frequency of review could vary from daily to monthly. The time taken to make up the shortfall varies from a week to a month. The less frequently he reviews and the more time he gives you, the better.
Zero in on the lender. Choose a lender who gives you the maximum possible loan amount for the least number of shares you pledge.
- Power of attorney (signed and notarised) from borrowers or guarantors as they may have to be submitted to the bank. Borrowers and guarantors (if any) are required to get their signatures verified by the existing bankers as per the format provided by the banker.
- When you pledge shares belonging to others, the co-applicant or shareholders have to sign a letter of continuity, a letter signifying their consent to the pledge of shares.
In the case of physical shares
- Share certificates along with signed, valid transfer deeds (not more than a month old).
- Photocopy of dividend warrants of the shares and units to be pledged.
- Allotment letter for rights or bonus shares from the company, or broker contract note specifying share certificate and distinctive numbers.
- Covering letter from the company received by the shareholder at the time of transfer.
In the case of demat shares
- Transaction request form allowing lender withdrawal of shares.
- Photocopy of the dividend warrants of the shares and units to be pledged.
- Covering letter from the company received by the shareholder at the time of transfer.
- In cases where shares are pledged from accounts with depository participants other than the lender DP, you have to submit a valid pledge mark report along with lodgement schedules.
How to maximize the tax benefit
A housing loan entitles you to some tax benefits, which bring down the cost of your loan. Bear these points in mind while computing the cost of your loan:
Tax breaks on a housing loan. All resident Indians are eligible for tax benefits on both the principal and interest components of a loan under the Income Tax Act, 1961. You are allowed a maximum deduction on interest of Rs 1,50,000 every year (for a loan contracted on or after 1 April 1999). For and from the financial year 2002-2003, the deduction of Rs. 1,50,000 will be available only if the construction or purchase of the house property is completed within three years of taking the loan. Under Section 88 of the Income Tax Act, you are eligible for a tax rebate on the principal repaid annually, subject to a maximum of Rs 20,000 a year.
Tax savings. To compute your tax benefits, you need a schedule that breaks up your EMI (equated monthly installment) into interest paid and principal repaid every month so that you can calculate the annual interest paid and principal repaid.
The tax savings on account of interest paid can be arrived at by multiplying your tax bracket (including surcharge) with the yearly interest paid. You get a rebate under section 88 on Rs.20,000 of principal repaid. Remember to factor in the maximum allowable under both heads.
When to exploit the tax breaks. If you are in the 30 per cent tax bracket, you can get a maximum tax saving of Rs 47,250 a year (after taking into account the 5 per cent surcharge) on account of interest paid every year. Multiply your tax bracket (30 per cent and a 5 per cent surcharge) by the maximum interest deduction you can claim, that is, Rs 1.5 lakh. The maximum rebate on Rs 20,000 principal repaid, of course, depends on the rate at which you are entitled to rebate u/s 88.
How to refinance a loan
Refinancing means having a financier take over a loan you've taken from another lender. Generally, you refinance when interest rates drop, making a new loan cheaper. Usually, you will have to find another lender to refinance your loan. Shop around for suitable lenders, and calculate comparative costs. Choose one that offers the most gains.
Calculate the gains from refinancing. Refinancing costs differ because the processing fee and interest rates might vary among refinances. You also have to consider the prepayment penalty on your old loan. Compare the cost of refinancing with the interest rate on the old loan. If the old interest rate is higher, it makes sense to refinance. To calculate the cost of refinancing, you'll need to check the principal outstanding on your old loan, tenure of refinancing and the interest rate at which the new loan is being refinanced.
You also need to know the prepayment penalty on the old loan and the processing fees on your new loan. The principal outstanding on your old loan is your new loan amount.
When you finalise the term of your new loan, you should refinance for the remaining tenure of your old loan or decrease the tenure. On no account should you increase the loan tenure; by extending it, you will pay interest for a longer period.
Also, find out how much the prepayment penalty on your old loan will be. It is usually 1-2 percentage points of the amount outstanding. This amount and the processing fee (the costs of refinancing) also need to be reduced. Or else, you will effectively get a lower loan amount at higher EMIs. So the actual cost of refinancing will become higher than what the new interest rate suggests.