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Vidya Bala

For those who thought that owning a home would remain a faraway dream, the new home loan package offered by public sector banks may make the dream a wee bit more attainable.

The package has, however, received a sober reception from the buyers as well as the developer community. The main reason is that the package offers concessional interest rates only for home loans of up to Rs 20 lakh.

This essentially means that unless you have sufficient cash stashed away to put in as own capital, you may not stand a chance of buying a home in the metropolitan cities.

On the positive side, loans below Rs 20 lakh account for over 70 per cent of banks’ loan portfolio, suggesting that a good number of home buyers do fall in this segment. The interest rates offered could also well undergo more cuts, with a further decline in market interest rates looking certain now.

Don’t forget that the property market is also turning into a buyer’s market, with price cuts resorted to by some realtors, and their willingness to negotiate prices. Lower interest rates, on top of this trend, may help tilt the balance in favour of a home buyer, especially from the lower- and middle-income group.

For buyers willing to invest in suburban areas, Tier III cities and satellite towns which could be the metros or emerging cities of the future, the time to scout for properties starts now. Here is a look at the features of the housing package that deciphers it for the first-time home buyer.

First, what is in the package? Effective December 15, public sector banks in the country have put on offer home loans at an interest rate of 8.5 per cent for loans below Rs 5 lakh and at 9.25 per cent for loans between Rs 5-20 lakh. This rate will be applicable for all new home loans taken up to June 30, 2009.

While the interest rates will remain fixed for the first five years, they will automatically be adjusted to match the lower rates offered by the bank over this five-year period.

Beyond five years, borrowers would have the option of choosing between floating or fixed rates. PSU banks will waive the loan processing fee and penalty for prepayment for these loans. A free life insurance cover for home loans has also been thrown in, as an added incentive.

What does the new interest rate mean for a loan-taker? For a 15-year home loan of Rs 20 lakh, for instance, at the new rate of 9.25 per cent, your Equated Monthly Instalment (EMI) would amount to about Rs 20,600 per month as against an EMI of Rs 22,420 per month at the earlier (highest) floating rates of 10.75 per cent.

Effectively, a borrower would save about Rs 22,000 per annum (or Rs 3.3 lakh over 15 years) on this loan, according to the new package. See Table for difference in EMIs over 5-, 10-, and 15-year tenures.

Tip: A buyer who had budgeted for his home at the old rates may find that he can afford a shorter tenure or an accelerated EMI, due to the lower rates.

But avoid going for ambitious repayment schedules as the annual increase in one’s income or changes in inflation may slow down under current circumstances. After all, you can choose to pre-pay the loan (without any charges), if you manage to save sufficient sums.

One’s investment and wealth creation plans should not also be curtailed to shell out hefty EMIs. As a broad rule, EMI and other expenses on the property, such as property tax and loan cover premium should not exceed 30-40 per cent of one’s annual income.

Interest is not the only cost attached to borrowing. Other expenses that are tagged to a loan include loan processing fee, life insurance taken to cover the loan until it is repaid and sometimes penalties charged by banks for prepayment of the loan. The new package relieves borrowers of these additional costs. The waiver of lending charges, such as loan processing fee, which typically works out to about 0.5 per cent of loan amount, with a cap of Rs 10,000, would reduce the overall cost of borrowing.

Similarly, the package extends free life insurance cover to the extent of the loan. Taking the example of a Rs 20 lakh, 15-year loan, a single premium loan cover term assurance plan could cost over Rs 40,000. The same could cost over Rs 1 lakh if paid annually. Further, if a borrower had surplus and wished to repay the loan ahead of schedule, a pre-payment penalty of an average 2 per cent (subject to date of prepayment) is levied by some banks on the amount repaid in excess of the normal EMI. For instance if you choose to prepay an outstanding loan of Rs 5 lakh at one shot, then Rs 10,000 would have been the penalty. So, the add-on benefits alone could leave you with at least Rs 50,000 (for the given example), in your pocket.

If corporates are today dogged by margin pressures, home loan buyers face a pressure of a different sort. With a property price correction in the offing, banks and lending institutions insist on a certain proportion of own capital — called margin money — to be brought in by the home buyer.

State Bank of India requires margin money of 25 per cent of the home value for loans up to Rs 30 lakh. For a property costing Rs 24 lakh, a buyer has to bring in at least Rs 8.5 lakh as his own money and can borrow the balance from the bank.

The new package now reduces this margin to just 10 per cent for a loan below Rs 5 lakh and 15 per cent for a loan between Rs 5-20 lakh. This incentive is seemingly positive; in the above example it would suffice if a buyer brings in less than Rs 4 lakh, instead of Rs 8.75 lakh.

However, the catch lies with the Rs 20 lakh ceiling for the package. To enjoy this whole package the buyer has just two choices — one, to hunt and settle for a house that costs less than Rs.24 lakh, so that one may bring in just the minimum amount required (15 per cent) by the bank. Or alternatively, go for a higher value home but bring in more capital and borrow only up to Rs 20 lakh.

Tip: While this may well rein in the demand spurt that the package is expected to spur, it may be best not to stretch the margin to the hilt. Putting up a higher margin is a prudent way of balancing one’s debt-equity ratio.

Experts say that even though banks may slash the margin money and offer a higher loan amount, accepting about 80 per cent of the bank’s offer is a prudent approach unless one is confident of a sustained increase in income. For instance, if a bank offers loan up to 85 per cent of the property cost, one can consider borrowing up to 70 per cent.

Why? For the simple reason that the bank’s calculation of one’s capability to service debt may not be completely accurate, as the bank may not have a complete picture of your spending patterns and loans.

One shortcoming of the package is that it is applicable only for new home buyers. In other words, one cannot switch loans taken earlier to a PSU bank, to gain from these reduced rates. This appears fair enough from the point of view of the Government as the objective of this package is to boost real estate demand.

Nevertheless, the package throws open wide opportunities for those who already own homes and are looking at investment opportunities.

More Stories on : Housing Finance | Insight | Interest Rates | Investments

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