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An introduction to home loans and factors to consider

This article is an introduction to home loans - it talks about fixed and floating rates, admin and processing fees, tenure, down payment, prepayments and prepayment penalty, foreclosures, etc.

In "Settle early in life - buy a home when young", we discussed that more and more people are opting to buy a house when they are very young, and very rightly so. We also saw that home loans are a big facilitator for this - home loans make it very easy for anyone to buy a home.

So, let's discuss what factors you should consider when you are taking a home loan. Please remember that although some factors (like interest rate) are more important than others (like freebies offered), you should look at all the factors before finalizing the home loan provider.

Rate of Interest

This is the single biggest factor while taking a home loan. The lower the interest rate, the better it is. This is because if the rate of interest is less, you would pay less every month towards interest, and pay more every month towards principle.

A lower interest rate also obviously reduces the monthly payout or the EMI. A lower EMI is easier to repay.

Lower interest rate also means that you would be eligible for a higher loan amount for a given income level.

Also remember that the interest rate is higher in case of fixed rate loans compared to floating rate loans.

Bottomline: Go in for a bank that offers a lower interest rate.

Type of interest rate - Fixed / Floating

You need to check if the bank you are considering offers the type of interest rate that you want. All banks offer floating interest rate, but these days, many banks do not offer fixed interest rate.

To know whether you should opt for fixed or floating interest rate, please read "To float or not to float, that is the question!".

Bottomline: Go in for a bank that offers the type of interest rate you want.

Tenure

Check the tenure for which the bank offers the loan - most banks offer home loans for upto 20 years, but some banks also offer home loans for 25 years.

A longer tenure means that the EMI would be smaller, and you would be eligible for a higher loan amount.

But longer tenure also means that you would end up paying more in the form of interest over the life of the loan.

So, balance these two according to your needs, and decide on the tenure.

Bottomline: If you decide on a tenure upto 20 years, any bank should be fine. But if you want a loan for more than 20 years, do check if the bank you are considering offers it.

(Also check out: "Home Loan / Mortgage Insurance – What to Buy, How to Buy")

Down Payment / Percentage of amount given as loan

Every bank asks for a certain percentage of the loan as down payment. (This is the bank's way of ensuring that the person taking the loan has a stake in the house from the very beginning).

This down payment can be as low as 0% in special cases - for example, if a builder has tied up with a bank for his entire project. But in most cases, the down payment is between 10-15%.

This means that you would need to provide this amount upfront. And since home loans are for very large amounts, even 15% can be difficult to come up with.

Bottomline: Go in for a bank that asks for a lower down payment. That is, go in for a bank finances the maximum percentage of your home loan.

Calculation of interest - Daily / Monthly / Yearly Rest

This again impacts how much you pay as interest on the loan. This factor is not very important these days, as most banks calculate interest at daily or monthly rests. But do confirm this before you finalize your home loan provider.

To understand this better, please come back to read "Understanding EMI - What is Equated Monthly Installment?".

Bottomline: Go in for a bank that calculates interest on daily or monthly rests.

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Note: Please treat the opinion expressed here as a broad suggestion. Please consult your financial planner / investment advisor before making any investment decision.

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