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Brick by brick: Understanding how a home loan works

Applying for a home loan has never been so easy. However, you need to maintain a healthy credit score to make the process smooth.

brand stories Updated: Dec 14, 2017 13:35 IST
(Pixabay)

The housing finance market has witnessed many exciting moments in the last one-and-a-half decades. Competition among banking and financial institutions to grab the market share has resulted in many different types of housing loan products coming to the market. Interest rates also came down substantially on many occasions, giving a huge fillip to the industry. At the same time, an unceasing migration of young population to the bigger cities in search of jobs has imbalanced the demand-supply equation of the real estate industry to a large extent. With the rise of demand for better housing, real estate prices skyrocketed and became unaffordable for the most. Today, for the urban middle class, personal savings alone is not sufficient to purchase a house. They need to look elsewhere for finance.

In order to meet the financial needs of home buyers, banks and financial institutes offer many affordable home loan products. So, as soon as the buyer settles on a property, deciding on the loan that best fits his financial criteria becomes the next big task. First-time buyers are often filled with their own set of apprehensions about home loans. To help them get a good idea about home loans, we have noted down a few important points they should seriously consider.

Applying for a home loan

Though it may sound tedious at first, applying for a home loan has never been so easy. In order to help buyers fulfill their dreams, banks have made the process much simpler now. Moreover, there are housing finance companies that help to get approvals faster.

Home loan also comes bundled with several financial benefits. The borrower can avail income tax exemption on the interest amount paid towards the loan, while the principal amount can be declared as tax-free investment under section 80C of the Income Tax Act. These incentives prompt many to go for a home loan while buying a flat, independent house, or land, and also during renovation of their existing house.

Checklist of documents

● Photo identity proof may include PAN/ passport/driving licence/voter ID

● Address proof can include electricity bill/ passport/ registered rent agreement

● Home loan application form attached with a passport photo

● Income proof like pay slip, Form 16, or bank statement

● Investment proof such as mutual funds, LIC, etc., and residence ownership proof

● Residence address proof that includes licence/ utility bill/registered rent agreement

● A cancelled cheque for validating the bank account

● Employment appointment letter, in case the period of employment is for less than 1 year

● Bank statement

Based on the documents submitted, both banks and financial organisations check with CIBIL for the applicant’s credit score. In addition, they check income and expense of the applicant to evaluate his credit worthiness.

A closer look at home loan

Unlike in the past, when home purchases were largely dependent on personal savings, individuals now have the freedom to avail home loan from commercial banks—both private and public—and other financial institutes to fulfill their wish. So if you have already finalised the house you want to buy, it’s about time you finalize the home loan, too. The sooner you apply, the faster is the loan processed. In fact, to help homebuyers get the loan paperwork out of the way, few banks accept loan applications even before you have finalised the home you wish to purchase. A pre-approval expedites the loan disbursement when you have settled on a property as the bank would have already evaluated your credit eligibility.

While applying for a loan, an applicant often has several questions in mind. Most important being—how much loan am I eligible for? The answer to this is straightforward: it all depends on the applicant’s “Repaying Capacity”, which in turn depends on his monthly income and outstanding debt obligations. Yet another troubling question is—how to decide on a home loan, given that a plethora of home loan options are available in the market today. Of course, figuring out the loan that best fits your long-term financial goals is an onerous task; an applicant needs to check prevailing home loan rates at different banks and compare them thoroughly before settling on one. They must also watch out for any hidden caveats mentioned in the loan terms. In general, interest rate and terms associated with the home loans from banks as well as from various housing finance companies vary widely, and the borrower must be meticulous in his research. After all, it’s a long-term financial commitment that the borrower is getting into.

When it comes to loan approvals, borrowers must understand that their monthly income is not the single most important factor that influences their loan eligibility. There are several other factors that expedite or delay the loan approval process. The most important data that banks look into before deciding on a loan application is the borrower’s credit score. Having a good credit score of 750 or above makes the process smooth. Credit score ranges between 300 and 900. A score on the higher side puts the borrower on a more favorable ground. On the other hand, borrowers with lower credit score can find themselves in a tougher situation and may have to negotiate loan terms to get an approval. So, why not plan your expenses well in advance? Clear all your dues on time to build a good credit score over a period of time. Not to forget, a good credit score is also helpful in getting approvals on car loan and personal loan. Therefore, home buyers who wish to go for a home loan must keep a close check on their monthly expenses, savings, outstanding debts, and credit card bills to build a good credit score. All these factors together influence a lender to approve or reject a loan application.

One of the tools that loan applicants can use to decide on a particular home loan is the home loan eligibility calculator. It is the most effective way to know one’s eligibility and calculate the interest and EMI amount on a home loan. Additionally, there are many third party online home loan calculators that fetch prevailing interest rates from various banks and present a visual comparison chart for quick analysis. A comparison chart can help you zero in on a loan from a particular bank and you can be assured about the EMI outgo. It also allows the homebuyer to plan his savings in advance to pay for the down payment.

Home loans are generally quite flexible in their repayment terms. At any time, if you want to minimise your interest outgo, you can make prepayments and minimise the interest outgo on your home loan and reduce the tenure.

So, if you wish to buy a home, start researching for popular home loan products in the market. Do spend some time in going through loan terms and at the same time, work on your credit score. With a healthy credit score, you stand to benefit from favourable home loan terms.