Scanning the fine print of a home loan

Buying your dream home can be very exciting, but don't rush through the paperwork so you can get your hands on that title deed. Remember your home loan may eat up a lion's share of your salary over many, many years. Scan your loan agreement thoroughly to understand what each clause implies before you sign on the dotted line.

Look out for

Rate of interest: The rate of interest determines the EMI or equated monthly instalment. The rate of interest, generally, can be of two types - fixed and floating though the latter is the most common these days. There is another addition to this category now called teaser loans which costs you less in the first few years.

Changes in Base Rate: Base rate is determined by an individual bank depending on various internal parameters including RBI's changes in repo and reverse repo rates. Banks cannot lend at a rate lower than the base rate. The floating interest rate would be the base rate plus a spread. The spread is the premium the banks charge from customers. The base rate is an important tool in a bank's armoury and often makes changes to it in response to the market conditions. The consumer is impacted due to this as interest rate changes with change in the base rate.

Reset clause: In the case of a fixed interest rate, the rate is usually fixed but there is a reset clause which allows banks to reset the fixed interest rate in relation to base rate at particular intervals.

Force majeure: This phrase means ‘greater force'. This implies that banks can raise the interest rates in exceptional conditions, even in a fixed rate loan. However, defining such a condition is left to the discretion of the bank.

Pre-payment penalty: The pre-payment clause explains the penalty that is charged if you decide to close the loan early by paying the amount due. Some banks do not impose any penalty while others differentiate this according to circumstances. For instance, when you refinance the loan through another bank opting for a lower interest rate such a pre-payment may involve a different and heavier penalty from the bank where you currently hold your loan.

Defining a Fault: For you a ‘fault' could simply mean not paying your EMI at some point in your loan tenure. However, some banks specify a fault as a case when the borrower expires, the borrower is divorced and stops paying (in case of more than a single borrower), or the borrower is/are involved in any civil litigation or criminal offence. Therefore, you must be clear about what your lender means by the term ‘fault'.

Security cover : This clause states that a bank is eligible to demand additional security when property prices fall. Such a demand could exist even if you are very regular with your EMIs. In such a scenario, if you are unable to provide a security cover in addition to your loan amount chances are that you could be declared a defaulter by the lender.

Interpreting the clauses

Remember that a borrower's goal is to get the loan at the least expensive interest rate while a bank's goal is to lend at a profit. Keeping this objective in mind, we will discuss the meaning of these clauses.

Teaser loan features: Teaser loans charge you less interest first and then increase it to the market rate.

If you are opting for this, make sure you understand the interest rate you will pay for the life of the loan. Most of the borrowers look at the next 1-3 years EMI and decide accordingly. The right way is to see the projected EMI after 3-5 years when the teaser rates are done with.

Floating rate loan: The banks increase floating interest rate as soon as RBI raises rates but do not lower it with the same enthusiasm.

Fixed rate loan: Though fixed rates are fixed over the period of the loan, banks insert a clause for resetting the fixed rate based on market conditions. Considering this aspect, it could be better to opt for a floating rate as you might get the benefit when market conditions turn favourable for a lower interest rate.

Pre-payment penalty: Discuss upfront with your bank about the prepayment penalty they charge and whether it works differently when you opt to prepay and refinance the loan.

Make sure everything is in writing. Currently RBI has already insisted on implementing a measure to do away with prepayment penalty completely.

Discuss this with your bank and see if you can avoid paying a prepayment penalty at all.

Points to note

- Try to arrive at a rough estimate of the effective interest rate you will need to shell out for your teaser loan and see if that can fit into your long term budget easily. Teaser loans can work to your advantage if you plan to close the loan in the short term i.e. 5-6 years.

- Though banks reduce interest rates as per the reduction in base rate it could still be applicable to new borrowers only. Again the RBI has stressed that the benefits should be passed on to existing customers as well, so figure out with your bank if that could be possible in your case.

Last but most important, document the discussion and take everything in writing. A home loan is too important to be taken on the basis of verbal assurances.

(The author is CEO, Bankbazaar.com, an online marketplace for loans)

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