India has been proudly wearing the mantle of being a nation of savers for generations now. As a country, steering clear of borrowing in favour of saving has been a part of our DNA.
However, over the years we have transitioned from being a nation of savers to a nation of investors and borrowers. As individuals we all want to improve our lives and often turn to borrowing in order to meet multiple short-term and long-term goals that vary from something as simple as taking a vacation or buying a car to purchasing a house.
Considering that getting a loan has become extremely easy, it is imperative for individuals to be responsible in their borrowing behaviour and ensure that the financing used to buy an asset does not become a long-term burden. And this responsibility starts even before availing the loan. In case of long-term loans like a home loan, it becomes even more critical.
Things to consider when you take a home loan
Having your own home is a requirement for all and it often necessitates taking a loan. Thus, it is advisable to be prudent and consider some important things before taking a home loan.
- Ensure fitment between the means and the end: Start with defining the purpose of the home loan - whether it will be owner-occupied or an investment property. Since property as an investment is fraught with risks, taking a home loan for investment purposes needs careful thought. Property prices don’t always increase as envisaged and can fall or even remain stagnant for extended periods of time. There is also the risk of non-completion of the project in time, rise in interest rates, etc. Thus, if a property has been purchased with the sole purpose of generating investment returns, then the expected returns may never materialise.
- Be conservative with your EMI: Often one keeps the EMIs high under the assumption that income will increase over a period of time and servicing the loan will become easy. However, this is not advisable. It is always best to have a conservative approach towards EMI and use any spare cash, bonus payments, and accumulated savings to prepay the loan. Further, one should also ensure that 2 to 3 months of instalments are kept aside in a safe and liquid instrument such that in the event of any unforeseen challenges, one has a financial cushion and the probability of a default reduces.
- Structure the loan judiciously: Be aware of the possibility of a hike in interest rates. This can lead to two consequences - increase in the EMI or increase in the tenure of the loan or combination of the two. In either of the situations the budgetary assumptions made will go haywire. One way to manage this is to remain conservative and keep the loan amount and the resulting EMI low.
- Invest in insurance: One thing that we often overlook as individuals is insurance. A good loan protect insurance can ensure that in the event of an untimely death of the borrower, the outstanding amount is paid by the insurance company. This unfortunate scenario has played out in several households during covid times. The obligation of repayment has fallen on the co-borrower(s) or legal heirs who often happen to be either children or elderly parents or non-working spouses. A loan protect insurance ensures the family doesn’t have to deal with financial distress in addition to the emotional trauma of losing a loved one.
- Scale up gradually: Due to familial and social pressures, people often end up purchasing an expensive house in a posh area simply because of the ‘status’ value associated with it. To fund this purchase, they end up over- extending themselves and then find it challenging to keep up with the EMI payments. It is better to purchase an affordable house and treat it as the first rung of the ladder and scale up gradually as your income grows.
- Account for extras: People tend to forget that the purchase price is just one aspect of the house. There are always additional expenses like taxes, interiors, etc., which require outflows and you need to take them into account, else one ends up taking personal loans which add up to the financial burden.
Having procured a home loan, it is equally if not more important to maintain it and having a disciplined approach is integral.
Things that are helpful to help repay loans efficiently:
- Make part payments: Use bonus pay-outs, accumulated savings to make pre-payments and reduce your liability at a faster rate. This will help in reducing the principal which in turn reduces the interest and both the tenure of the loan and the EMI can be brought down.
- Don’t delay your EMIs: Be disciplined about your EMIs. In the event of stress, don’t allow delays to exceed 90 days. Your loan becomes an NPA in the books of the bank or lending institution if your dues are unpaid for 90 days and their recovery mechanism sets in. This may eventually result in you losing possession of the property.
- Use soft loans to tide over: If you find yourself in a situation where you are temporarily unable to pay your EMI, evaluate taking soft loans against your liquid assets like FDs, gold, etc., after you have exhausted your cash reserves.
- Renegotiate with the lender: If you are facing a more long- term loss of income or permanent disability to service the loan, reach out to the lender and renegotiate. You can also seek alternate options which may include selling off the asset and buying a cheaper asset, using the proceeds to pay off the liability.
Taking a home loan as it is not only a step towards realising your goals but also a long-term commitment that can have ramifications on the other aspects of your life. Your credit history and past payments not only impact your credit score but also subsequently impact your future access to credit. A good credit score ensures that one is able to access credit at compelling rates. The steps elucidated above are simple and easy to follow and could put you well on your way to responsible borrowing behaviour.
Sanjay Agarwal is Head of Retail Assets Business, Edelweiss ARC