On popular demand here comes the much awaited article on Home Loan. I plan to cover some of the do’s and don’ts while opting to avail a loan to own that dream home of life time. This post comes soon after me closing our home loan account, so I sure do qualify to share my learnings. Yes, you read it right, I just closed my home loan account over the last weekend! I can tell you one thing for sure, nothing can match the sigh of a relief one can feel after closing the loan on their first ever dream home :)
Planning before deciding on a home loan:
Rule #1 – know your affordability. Decide on your preferences like whether you wish to go for an independent home or an apartment flat. Then choose the location that fits your budget. If you are looking at a considerably high budget home which might be just a little too pricey, think of having your spouse or parents as co applicants. That will help you avail higher loan amount since the combined affordability ensures the bank about a safe payment of EMIs. By having a co-applicant, you have an option of sharing the EMI payment on a percentage share basis. Accordingly, both the applicants will be able to avail tax benefits. Given that there exists a cap on the interest paid towards home loan is subjected to a max of 1.5 lacs per individual, sharing the EMI between individuals make a better utilization of the tax benefit provision. This is advisable only for those where in both the applicants are working and paying tax out of their incomes.
Few banks do impose rules like the co-applicant must be the co-owner of the property which you are planning to purchase. So make sure you have thought of all these things in the initial phase itself. Also ensure you have all the required documents even if you are going for a construction loan on an existing property. Once you have all the documents, it is easy to avail the loan and to strike the best deal among the lot in minimal time.
Choosing the loan:
While you are in the initial phase itself start researching about the various home loan products by at least 5 different banks belonging to both private and public sector. This gives you a very good competitive edge to evaluate the best product that suits your needs as well as a good learning of the industry. When I was in this phase precisely 5 years back, I got to know about all the conventional terminologies like ‘Fixed’, ‘Floating’ interest etc., Also, came across a product by ABN Amro bank which offered a mix of both! Since I was new to borrowing business by then, opted to go with a plan called ‘All Smiles Home’ which had a combination of both fixed and floating rates. I zeroed on a deal by ABN that was pegged at a fixed rate of 7.25% pa for first 3 years, 7.5% pa for 4th year, 7.75% for 5th year and floating rates there after for rest of the payment term! Usually fixed interest products are a bit high compared to floating ones. Though I could have opted for floating rate which was anywhere between 6.75 to 7% at that time. I chose the said plan as I was not willing to risk myself to variable rates every 6 months or a year. This also helped me to plan my finance better since there were a number of things in the pipeline. I think this is a smart move for any individual who is planning for a home loan and has started the career a couple of years back.
Few more things to keep in mind while choosing a home loan include various options like prepayment facility, charges on prepayment or foreclosure, periodicity of rate change etc., Some of the banks don’t allow prepayment while others allow up to 25% of the outstanding amount at the beginning of a financial year and few other banks don’t levy any penalty at all! I chose a loan that gave me an option to prepay 25% of the outstanding amount every year without any charges and provided an option to close my loan completely after 5 years without any extra charges. Some banks do provide home loan insurance at a nominal cost. If you don’t have enough risk cover on the applicant/s, opt for this insurance so that the loan burden is protected incase of unfortunate events. You may want to go through related articles on life insurance here.
During the loan tenure:
After availing the loan and while you are on EMIs, plan your investments with utmost care. Your aim should be to close the home loan account as earlier as possible. Since the interest component of your EMI would be very high compared to principal amount, most of the money paid towards the loan would be towards interest component and principal stays very much at the borrowed level unless you plan for some prepayment during the initial years. Prepayment can bring in a lot of benefit since it reduces the principal directly and there by interest component % gets reduced on the EMI.Whenever you make a prepayment, always opt to reduce the tenure of the loan period than to reduce the EMI. This way you will be able to close the loan account in a lesser period compared the actual tenure for which you availed the loan.
If you continue to pay EMI’s without any prepayment, usually you end up paying ~1.8 to 2x times the borrowed money! So, tax saved from your income is actually paid to make the banks profitable! Of course, the relief is that you have a own home as an asset at the end of the loan period. Based on your affordability plan to close the home loan account anytime around 6-8th year, backed up by intermediate prepayments on a yearly basis. This will save you lot of money! Now your question might be on the lines of ‘What about tax benefit?’ if the loan is closed. Well, the answer is actually there is no benefit after few years as the principal component in your EMI increases while the interest component gets reduces drastically. Now that the home loan principal component is a part of section 80C (max 1 lac), and most of it gets easily filled with your insurance and pf contributions. Similarly interest component may be much lesser than 1.5 lacs. Upon closing the loan account and by paying the tax to government there after, our infrastructure gets better and we get to feel the benefits. But if you continue to hold the loan, you are just making the bank more profitable by paying heavenly interests! Now I don’t want to get in to numbers to prove that, you folks are smart enough to calculate after reading so many articles related to finance on this blog I suppose.
If you have any questions, feel free to post them under comments section. I shall answer them to my best to help you :)