15 Home Loan Terms you must know before applying for a home loan
The jargon of various home loan terms used by the home loan sales people sometimes becomes confusing. This is a list of 15 questions that you would come across during the home loan process that you must know before applying for a home loan. These terms have been put in simple easy to understand language from the layman’s perspective.
What is a pre – approval of Home Loan?
In case a customer wants to get a pre-approval of the loan done without first finalizing the property; he can do so by making the application in a similar fashion as a normal housing loan application. However some companies require a declaration from the customer that he is applying under the pre-approval and hasn’t identified the property. Wherever such declaration is not there; one can always write in bold letters that this application is for a sanction of the loan without finalizing the property.
What is an EMI?
EMI (Equated Monthly Instalment) is the amount payable to the lending institution every month, till the loan is paid back in full. It consists of interest due as well as a portion repayable towards the principal, therefore EMI is principal plus interest. The interest is charged on the outstanding principal at the end of every month. There is a myth; many people tend to believe that the banks charge high interest in the beginning and low interest towards the end to charge more interest. The fact is if you calculate the interest charged at any given point in time would simply be the interest charged on the outstanding principal for that month. Since the principal outstanding during the first 6-7 years of a 20 years loan is very high the portion of interest in the EMI is also high.
What is pre EMI?
In case of under construction properties; where the possession of the property would be offered at a later date, to avoid the extra burden on the borrower, who is on a rented accommodation and is also simultaneously paying the rent. The banks / HFCs offer the facility of deferring the EMI till possession or for a particular period. The payment of interest for such a period is called as the pre emi interest.
What are Daily Reducing, Monthly Reducing and Annual Reducing?
Annual reducing: In this system, the principal, for which you pay interest, reduces at the end of the year. Thus you continue to pay interest on a certain portion of the principal which you have actually paid back to the lender through EMIs paid during the year. This means the EMI for the monthly reducing system is effectively less than the annual reducing system. EMI as a concept is based on monthly reducing only.
Monthly reducing: In this system, the principal, for which you pay interest, reduces every month as you pay your EMI.
Daily Reducing: In this system, the principal, for which you pay interest, reduces from the day you pay your EMI. EMI in the daily reducing system is less than the monthly reducing system.
What is a fixed rate of interest?
Fixed rate of interest means that the rate of interest remains unchanged for the specified duration of the loan. This means you do not benefit, if rates of interest drop in the market. Similarly you do not lose if rates of interest increase. Under fixed home loan rates also, banks/HFCs retain the right to increase the rate of interest after the prescribed interval. This provision is mentioned in the loan agreement. This is known as reset clause in the fine print.
What is a floating rate?
This is the rate of interest that fluctuates according to the market lending rate. This is also called as the adjustable interest rate in some cases. The adjustable interest rate is bench-marked to a Base rate by the banks and to PLR by the HFCs.
The benchmark base rate or the PLR changes as the interest rate changes by the RBI.
What is the reset clause?
Reset clause in a loan agreement is a clause which defines the interest rate reset time and other terms & conditions. This reset clause is generally set in fixed rate loans.
What is Base Rate?
Banks in India link all the lending to Base Rate. Base rate of a bank is the bench mark rate and all the lending is pegged to this rate. The base rate of a bank is determined by the cost of funds plus an interest margin. The cost of funds is supposed to be lower for a bank which has high current account & savings account balance (CASA balances). Banks charge a margin on the base rate for different products. E.g. SBI home loan upto Rs 75 lacs are available at 10.15% and the base rate of SBI is 10.00% currently. This means SBI is charging a margin of .15% for home loan on base rate. This margin would remain constant throughout the term of the loan.
What is Prime Lending Rate?
Housing Finance companies like LICHFL, HDFC & PNBHFL etc lend on Prime Lending Rate. Each HFC would have a different name for its PLR, but it means the same. E.g. LICHFL calls its PLR LHPLR and HDFC calls RPLR. The PLR is generally a high number and these companies give a discount to the PLR to arrive at the effective rate of interest to be charged to the customer. This discount is the single most important factor and the reason why the loan to an existing customer is at a higher rate and loan to the new customer would be at a lower rate. Because these HFCs have adopted this practice that they don’t reduce the PLR so quickly and give a higher discount to the new customers.
What is better PLR or Base Rate?
Base Rate is better for two reasons: 1) Banks have access to low cost funds in the form of CASA balances and 2) the margin charged on the Base Rate is generally a small number, and there is less flexibility with the bank to tweak it too frequently.
What is construction linked plan?
Under the construction linked payment plan, the buyer of the property is required to pay money in installments as the stage of the construction progresses. The Home loan so taken is also disbursed in stages and doesn’t put pressure of EMI on the borrower immediately. Therefore people living in rented accommodations can opt for this type of plan.
What is approved project funding?
For facilitating individual borrowers and to avoid inconvenience to the individual property purchasers the banks don’t ask for the complete set of the property papers of a particular project from individual borrowers, instead the builder is asked to provide such documents to the bank. The bank after doing its due diligence approves the project for funding. This is called as Approved project funding or generally referred to as APF. The builder generally approaches only 4-5 banks to get the project approved. However it doesn’t mean that the other banks cannot fund the project. The only difference would be that the individual borrower would have to run around and provide the documents to the banks. It would be ideal that a borrower approaches a bank which has already approved the project for funding to avoid the running around.
What is prorated Home loan?
For young individuals in the early stage of their career, it is difficult to pay a large lump sum as a part of their contribution at the time of booking an under construction property. Therefore they can opt for funding their contribution in the same proportion as the bank’s contribution as the construction stage progresses. However some banks ask for a minimum 15% of the cost of the flat is too paid by the borrower upfront. The bank starts disbursing afterwards. However at any time the share of the HFC / Bank cannot exceed the percentage share by the borrower.
What is the Security required for home loans?
In most cases, the property to be purchased itself is the accepted as the security and is mortgaged to the lending institution till the entire loan is repaid. In case there is a problem with the creditworthiness of the customer or the property being financed is not fully technically compliant, the lending institution may ask for additional collateral as well. Some institutions may ask for additional security such as life insurance policies, FD receipts and share or savings certificates.
What is second charge?
In some cases employers such as banks / Govt institutions offer loans to their employees at very subsidized rates. However such loans don’t suffice; since the value of the property is much higher. Therefore the borrower requires a loan from some other bank / HFC as well. The property which has already been mortgaged to one institution if accepted as collateral by the second lender is called as the second charge. Banks / HFCs accept second charge from the central Govt Departments and some PSUs as well. One should clarify in advance before applying for a second home loan on the same property.