Each one of us, at some or the other point in life, dreams of becoming a homeowner. Having a house to call our own is the surest way of being financially secure. It is an asset that stays with us for life and it is something we can pass on to our children, thus securing their financial future. But the process of buying a home is not as simple as it appears.
With property rates skyrocketing, most people can only afford a small percentage of the actual rate of the house as down payment. The rest of the amount is secured as a home loan. Part of preparing for a home loan is to be aware of all the terms associated with this loan. Before we understand all the home loan terminology, let's understand what it means to take a home loan.
What is a home loan?
A home loan is simply the amount of money that one can borrow from a bank, a non-banking finance company or a housing finance company at a fixed or floating rate of interest. The borrower can repay the loaned amount in affordable EMIs over a stipulated tenure, usually lasting up to 30 years. For a property to qualify for home loan it needs to be either a personal or commercial property.
One can choose from various types of home loans. Let's begin by understanding the home loan terms for the various kinds of home loans.
Home Purchase Loan: The most common type of home loan, this kind of loan helps you purchase a property, flat, or apartment that is either under-construction or the construction for which, is completed.
Home Construction loan: This is a loan taken by individuals who already own a plot or piece of land and which to construct a property on it. This loan is ideal for individuals looking to build a new house on their plot.
Home improvement loan: A home improvement loan typically covers all the expenses related to renovating your home be it painting, remodelling, fixing leaky ceilings, and electrical repairs and so on. You can either take an unsecured home improvement loan for a higher interest rate or pledge your home as collateral to get a lower interest rate.
Land Purchase Loan: Another important home loan term is land purchase loan. If you wish to purchase a plot of land to construct your home the way you deem fit, you can take out a land purchase loan. Such loans are usually taken by people looking to build farm-houses, bungalows and villas and the plot serves as the collateral.
Home extension loan: In case you decide to do some remodelling and add another room, like a dining room, a storage room or simply make two smaller bedrooms out of one large bedroom, you can apply for a home extension loan. This loan also allows you to add another floor to your current home.
Joint home loan: When two people are named in a home loan, it is regarded as a joint home loan. You and your spouse could register as joint home owners and reap the benefits from tax deductions associated with home loan, if you are both listed as co-borrowers for a home loan.
Home loan Balance Transfer: A home loan balance transfer allows you to switch the outstanding loan amount to another lender who offers a lower interest rate and better terms and conditions.
Top-up home loan: In case you need more money exceeding your outstanding loan amount, you can opt for top-up home loan.
In the above home loan terms explained, we have often used the word collateral, which is a common terminology associated with home loans. So, let's begin the explanation of the other important terms associated with home loans, with collateral.
Collateral/Security: Since the home loan amount typically ranges between lakhs and crores, lenders require some sort of asset as security in case one is unable to repay the loan. This is known as collateral. The term security is also used interchangeably for collateral since the lender uses the pledged asset as security if one defaults in repaying the loan amount. A home loan provided against collateral typically comes with a lower interest rate as the collateral serves as protection for the lender. In case of a home loan, the property for which the loan is provided is generally regarded as security. This gives the lender the legal right to recover the outstanding amount of the loan by selling off the property in question if a borrower defaults in repaying the loan.
EMI: EMI stands for Equated Monthly Instalments. A borrower can repay his loan amount in monthly instalments. The EMI constitutes both, the principal and interest component of the loan. The EMI amount is pre-calculated and determined by your lender basis the interest rate and tenure associated with the loan. The borrower must continue paying EMIs until the entire principal loan amount and interest is paid off.
Tenure: Lenders offer home loans for a specific period of time. You can pay off your home loan principal and interest amounts in EMIs with tenures lasting from 20-25 years. In some cases, home loans are offered for tenures of up-to 30 years. If you opt for high tenured home loans you must pay high interest rates.
Interest: Interest refers to the amount the borrower must pay to the lender, over and above the principal loan amount sanctioned. Borrowers can choose from two types of interest rates on their home loan i.e. the fixed rate of interest and the floating rate of interest.
Fixed interest rate: A fixed interest rate simply means that the borrower can repay the home loan at a fixed rate throughout the loan tenure. In such a situation, the monthly instalment amount remains the same for the entire loan tenure. This rate is ideal for meticulous budget planners.
Floating interest rate: A floating interest rate fluctuates or changes along with market conditions. If one chooses a floating interest rate he/she ends up paying a different EMI amount each month, based on the base rate.
Base rate: The base rate refers to the minimum interest rate set by the lender. This is the benchmark rate below which the lender cannot offer a home loan. Each time the base rate changes, the floating rate is also changed.
Margin: When it comes to home loan terminology, margin is a very significant term. In the case of home loans, the terms margin and down payment are used interchangeably. Margin is simply the difference between the loan amount provided by the lender and the actual property value. Most lenders typically provide 80% of the actual property value whereas the borrower must bear the remaining 20% amount as margin or down payment. So if you wish to purchase a property worth ?1 crore, you must pay ?20 lakhs as down payment while your lender offers ?80 lakhs as loan amount.
Credit Appraisal: Before you loan is sanctioned, the lender carefully considers your loan request by considering several parameters. These include your income, savings, age, employment status and credit scores. They will also check your outstanding bills; you credit repayment behaviour, your monthly credit card debt and so on. These factors help them determine whether or not you are eligible for a loan and if you are, what loan amount should be sanctioned to you. This is known as credit appraisal.
Disbursement: The process of releasing the loan amount from the lender to the borrower is regarded as disbursement. The loan amount is disbursed only after the lender receives all the documents and the loan is approved. Disbursement can be of three types:
Advance disbursement: This refers to the entire disbursal before a project is completed. Advance disbursement is only done on request on the understanding that a builder will complete the project within the stipulated time frame.
Partial disbursement: This is when the lender releases only a partial or limited portion of the loan amount to the borrower.
Full disbursement: When the lender disburses the entire amount of the loan in one go, it is known as full disbursement.
Pre-EMI: EMI payments begin after a loan is completely disbursed. Until then, the borrower must pay the lender an interest rate on the partially disbursed amount. This is known as Pre-EMI.
Offer Letter: Also referred to as sanction letter, this is the formal confirmation sent by the lender stating that your loan request is considered. The offer letter typically contains details regarding the loan amount, interest rate and type, the loan tenure, the monthly payments or EMI amount, terms and conditions, etc. An offer letter is only valid for a period of six months in which you must complete the loan formalities. However, the offer letter does not mean that the loan is going to be disbursed. The loan amount is disbursed only after the lender is convinced the property and documents are in place.
Post-dated cheques: You must provide cheques which are dated ahead of time or post-dated, which the lender cashes on your EMI date. Typically the lender asks for 1-3 years supply of post-dated cheques and you must provide the cheques for the following years (throughout the loan tenure) from time to time. Post-dated cheques are addressed to the lender, must have the borrower's signature and the EMI amount.
Pre-approved property: Before lenders approve a loan request, they conduct a sanity check. They conduct some due diligence about the property you wish to purchase, the builder, the project etc., on their own. They will ensure that a property has clear titles. In several cases, lenders tie-up with builders, properties or projects in which case, the property may be considered pre-approved by the lender. In such cases, the builder can directly refer you to the lender for the home loan. Despite this, buyers must be aware of the home loan terminology called “Caveat Emptor – Buyer Beware.”, which means a pre-approved property may not necessarily be a safe investment.
Resale property: This is a home loan term used when one is purchasing a property from another home owner, who is selling his property. It is therefore regarded as a resale property. This simply means that one is not purchasing a brand new house directly form a builder or a property that is under construction.
Loan to value ratio: Often abbreviated as LTV, the loan to value ratio simply implies that the amount of the loan is divided by the total value of property. So if you take out a loan of ?80 lakhs for a property worth ?1 crore, the loan to value ratio will be 80%.
Pre-closure: In case a lender has adequate sums to close a loan before his chosen tenure he can opt for pre-closure or foreclosure. He can simply make a bulk payment to close off his loan. Depending upon the loan amount he has repaid, he may or may not be eligible for a penalty fee for closing the loan before the stipulated tenure.