In India, getting a home loan is a complex process, especially for first-time homebuyers. The intricacies of various mortgage loan terms often leave borrowers perplexed, which can lead to decisions that might not be in their best financial interest. It is not just about financial literacy; it is about empowering oneself to negotiate better terms, understand the obligations involved, and ultimately, make an informed choice. A key goal of this blog is to demystify the home loan process by explaining key terms used in Indian housing finance. Whether you are a first-time buyer or looking to refinance, a clear understanding of these terms will equip you with the knowledge to navigate the home loan terms in India landscape confidently.
What is a Home Loan?
A home loan or mortgage loan is a financial product offered by banks and other lending institutions to assist individuals in purchasing residential property. This type of loan is one of the most substantial financial commitments one can undertake. It involves borrowing a large sum of money, which is then repaid over a set mortgage loan period, usually spanning several years or even decades.
- Principal Amount
- Down Payment
- Interest Rate
- Processing Fee
- Loan-to-Value Ratio
- Top-up Loan
- Credit Score
- Balance Transfer
- Sanction Letter
- Fixed-Obligation-to-Income Ratio
- Stamp Duty and Registration Charges
- Prepayment Penalty
- Amortization Schedule
- Credit Appraisal
- No Objection Certificate
- Credit Linked Subsidy Scheme
1. EMI (Equated Monthly Installment)
The EMI is the cornerstone of a home loan, representing the monthly payment that the borrower must make to repay the loan. It's a fixed amount made up of both principal and interest components. The calculation of EMI depends on three main factors: the principal amount borrowed, the interest rate charged, and the mortgage loan period. In the Indian context, EMIs can be calculated using the reducing balance method, which means that the interest component decreases over time as the principal is paid off.
2. Principal Amount
This is the actual amount borrowed from the lender. Initially, a significant portion of the EMI goes towards paying off the interest, with a smaller component reducing the principal amount in home loan. Over time, as the interest component reduces, the contribution towards the principal amount increases. This is a critical factor in amortizing a home mortgage loan.
3. Down Payment
A down payment in a mortgage loan is the upfront payment made by the homebuyer, usually a percentage of the property's total value. In India, this ranges between 10-20%. The higher the down payment, the lower the loan amount required, which can result in more favorable loan terms and lower interest obligations.
4. Interest Rate
Home loan terms can have either fixed or floating interest rates. Fixed rates remain constant throughout the loan tenure, making budgeting easier. Floating rates, however, vary with market conditions and can impact EMIs. The Reserve Bank of India’s policies, inflation, and other economic factors can influence these rates.
Loan tenure is the period over which the loan will be repaid. Banks offer home loans with tenures as long as 30 years, though the shortest home loan term can be as brief as 5 years. Choosing the right tenure is a balancing act; longer tenures mean lower EMIs but higher total interest outgo, while shorter tenures increase EMIs but reduce the total interest paid.
6. Processing Fee
This is a charge by the lender to process the loan application. The processing fee varies across lenders and is typically a percentage of the loan amount. Some lenders also offer special waivers on this fee during promotional periods. Some lenders also offer discounts on processing fees to women borrowers. The processing fee is non-refundable and must be paid upfront.
Suggested read: Home Loan Fees and Charges in India
7. Loan-to-Value Ratio (LTV)
LTV is the ratio of the loan amount to the appraised value of the property. RBI guidelines restrict LTV ratios to a maximum of 75-90%, depending on the loan amount. This ratio determines how much funding a borrower can get against a property. The higher the LTV, the higher the loan amount. It is important for borrowers to understand the LTV ratio before applying for a home loan. Lenders may offer higher loan amounts if the LTV ratio is lower.
8. Top-up Loan
If a borrower needs additional funding, a top-up loan can be availed over and above the existing mortgage loan. This is subject to the borrower's eligibility and the property's value. The top-up loan can also be used for home renovations, medical emergencies, and other purposes. The interest rate on the top-up loan is usually higher than the regular home loan.
Pre-EMIs are applicable when the loan amount is disbursed in tranches, as in the case of under-construction properties. Borrowers pay interest only on the amount disbursed until the full loan is released, after which regular EMIs commence. These payments are usually higher, as the interest is calculated based on the total amount disbursed. Borrowers should be aware of the exact pre-EMI payments before applying for a top-up loan.
10. Credit Score
A credit score is a numerical representation of a borrower's creditworthiness. A high credit score can fetch you lower interest rates and better home loan terms. Regular repayment of EMIs, credit card bills, and other loans positively affects the credit score. Conversely, late payments, defaults, and judgments can significantly lower the credit score. Borrowers should strive to maintain a good credit score to avail of better loan terms.
11. Balance Transfer
This option allows borrowers to transfer their existing home loan to another lender offering a lower interest rate. This is a strategic move used by borrowers to reduce their EMI burden, especially when there is a significant difference in interest rates between two lenders. However, borrowers should keep in mind that balance transfers come with a fee and can affect their credit score. Therefore, they should carefully evaluate the pros and cons of this option before making a decision.
12. Sanction Letter
Once the loan is approved, the lender issues a home loan sanction letter, detailing the loan amount, interest rate, tenure, and other terms and conditions. This letter is crucial as it formally indicates the approval of the loan. The borrower needs to sign this letter and return it to the lender. The lender will then disburse the loan to the borrower. Once the loan is disbursed, the borrower can begin making monthly payments.
13. Fixed-Obligation-to-Income Ratio (FOIR)
FOIR is used by lenders to assess an applicant's loan repayment capacity. It represents the proportion of income already committed towards existing debts, determining how much additional loan the applicant can comfortably repay. FOIR is calculated by dividing the monthly repayments of existing debts by the monthly gross income. The higher the FOIR, the more an applicant can borrow. It is important to consider FOIR when applying for a loan, as it can lead to over-indebtedness if the repayment capacity is not taken into consideration.
14. Stamp Duty and Registration Charges
These are legal fees payable to the government when registering a property. The amount varies across different states in India and forms a significant part of the additional costs involved in purchasing property. The government charges these fees to cover the administrative costs of processing the registration documents, as well as to ensure that the sale of property is conducted legally. These fees are typically paid at the same time as the stamp duty and are calculated based on the value of the property.
15. Prepayment Penalty
If a borrower decides to pay off a part of or the entire loan before the tenure ends, banks might charge a prepayment penalty. However, RBI guidelines have restricted banks from charging prepayment penalties on floating-rate loans. The RBI has also issued guidelines to protect borrowers from unfair penalties. Banks are not allowed to charge a penalty if the loan is repaid within 12 months of the loan being disbursed. Additionally, banks are not allowed to charge a penalty if the borrower prepays the loan in full.
Foreclosure refers to the full repayment of the remaining loan amount in a single payment instead of EMIs. Indian banks may charge a foreclosure penalty, although RBI guidelines have made foreclosure charges nil for floating-rate loans. The foreclosure penalty is usually a percentage of the outstanding loan amount and is payable in addition to the loan amount. The borrower needs to pay the foreclosure penalty when they wish to foreclose the loan.
17. Amortization Schedule
This is a table detailing each payment throughout the life of the loan. It shows the breakdown of each EMI into principal and interest components and how each payment affects the remaining loan balance. Understanding the amortization schedule can help borrowers plan prepayments and manage their finances better.
Suggested read: Home Loan Subsidy
For home mortgage loans in India, the property being purchased usually serves as collateral. This means that in case of default, the lender has the right to recover the outstanding amount by selling the property. This type of loan is known as a secured loan, where the borrower's asset is used as collateral. This allows the lender to lend money to the borrower at a higher interest rate, as they are assured of getting their money back in the event of default.
19. MCLR (Marginal Cost of Funds-based Lending Rate)
Introduced by the RBI, MCLR is a reference rate for banks to decide the interest rate on loans. It ensures fairness in interest rates charged by banks, reflecting their actual cost of funds. MCLR is calculated by adding a spread to the cost of funds, such as the cost of borrowing from the central bank. Banks then use this rate to set their lending rates, ensuring that borrowers are charged rates that accurately reflect their cost of funds.
20. Credit Appraisal
The process by which a lender evaluates a loan application, considering the borrower's financial background, credit history, employment details, and other personal information to determine loan eligibility and terms.
A co-applicant shares the responsibility of loan repayment. Including a co-applicant, often a family member, can enhance the borrower's loan eligibility, especially if the co-applicant has a stable income and a good credit history.
A guarantor on a home loan commits to repay the loan if the primary borrower defaults. This adds a layer of security for the lender, especially in cases where the borrower's creditworthiness is not sufficient. The guarantor's creditworthiness is usually assessed before the lender offers the loan, and the lender may require the guarantor to provide collateral or a personal guarantee as a guarantee that the loan will be repaid. This allows the lender to mitigate the risk of default by the primary borrower.
23. No Objection Certificate (NOC)
After the loan is fully repaid, the lender issues an NOC. This document is critical for the removal of the lien on the property and is required during the property’s resale or transfer of ownership. The lender will also issue a satisfaction letter, which states that the loan has been paid in full and that the lender no longer has any legal interest in the property. This is the final document that the lender will provide to the borrower.
Suggested read: No Objection Certificate for Home Loan
24. Credit Linked Subsidy Scheme (CLSS)
Under the PMAY, the CLSS offers an interest subsidy on home loans for eligible categories of borrowers. This scheme aims to make homeownership more affordable for lower and middle-income groups in India.
With the inclusion of these additional terms, our guide on home loan terminologies becomes even more comprehensive. Each term, from EMI to CLSS, plays a pivotal role in the home buying and financing journey. Understanding these terminologies is crucial for anyone looking to navigate the complex world of home loans in India. As always, consulting with financial advisors and doing thorough research is advisable before finalizing any home loan arrangement. Remember, a well-informed borrower is not just better equipped to tackle the financial aspects of buying a home but also stands a better chance of finding the most cost-effective and beneficial financing options available.
FAQs About Home Loan Terminologies
The term of a home loan can vary greatly, depending on the borrower's financial situation and preferences. In India, home loan terms can range from 5 years to as long as 30 years. Shorter home loan terms, generally come with higher monthly payments but result in less interest paid over the life of the loan. Longer terms have lower monthly payments but increase the total amount of interest paid. The ideal term should balance the affordability of payments with the total cost of the loan.
The banking term for a home loan is typically referred to as a "mortgage loan" or simply "mortgage." This term signifies a loan specifically used for purchasing real estate, where the property itself is used as collateral to secure the loan.
Common terms used in loans, particularly in mortgage loans, include Principal (the amount borrowed), Interest Rate (the cost of borrowing), EMI (Equated Monthly Installment), Tenure (duration of the loan), Collateral (asset used as security), LTV (Loan-to-Value ratio), and Foreclosure (early repayment of the loan). These terms are essential for understanding how loans work and the responsibilities involved in borrowing.
The minimum period of a home loan can vary depending on the lender's policies and the borrower's requirements. In India, the shortest home loan terms can be as brief as 5 years. These shorter-term loans are less common and typically require higher monthly payments.
The maximum term of a home loan can vary between lenders but generally, in India, the longest term offered is 30 years (or 360 months). This extended term is chosen to make the monthly repayments more affordable, although it increases the total interest paid over the life of the loan.
Published on 9th January 2024