Six Home Loan Mistakes to Avoid

Published: February 11, 2009

The age-old fear of moneylenders has instilled a natural financial discipline among Indians. Yet, the heady growth over the past four years has lulled many into a false sense of security and put them at risk of falling into a debt trap.

Risks for borrowers increased manifold after the markets moved towards a floating rate regime and financial innovation created products that left them with a much larger liability than their initial borrowings. Future borrowers could perhaps take a leaf out of the book of mistakes that their predecessors have made in the recent past.

Loans with negative amortization: These are loans that are at the root of the subprime crisis. Described as loans with step-up repayment or accelerating EMIs, in India they are primarily targeted at young professionals. “The idea was to help such professionals with a desire to own a house in the early phase of their careers to achieve their objective,” informs Harsh Roongta, CEO, This is how it works: During the first two years, only the interest component is collected to ensure that the borrowers would be able to afford repayment and, subsequently, the repayment amount goes up.

The underlying assumption here is that the borrowers’ income would gallop as they move up the ladder. Many borrowers do not even know that they may end up having a bigger loan outstanding even after paying several EMIs. Negative amortisation can also happen if interest rates go up and the borrower does not increase her EMIs. The way to check whether this is a component of your loan is to ask for an amortisation schedule.

Not reviewing loan rates : Several borrowers have now realized that floating rates float up more easily than down. Thanks to ‘special’ offers, lenders are able to lure new borrowers with lower rates even while maintaining interest rates on existing loans. Very often, banks are willing to revise rates for payment of a flat fee of 0.5% to 1%.

Such adjustments are on mutual agreement since they are not a part of the loan agreement. If no such option is available, borrowers can consider shifting their loan if the interest rate differential or the residual maturity is enough to justify the 2.25% prepayment cost.

Borrowing on tomorrow’s income : After a few years of getting 20% increments, employees begin to take salary hikes for granted. What they do not realize is that if the projected earnings do not materialise on account of unforeseen reasons, their repayments could be adversely impacted. This is especially relevant in the current scenario where job security is under threat due to the global recession, and, even if the borrower is rewarded with salary hikes and bonuses, the quantum would be miniscule.

The desire to own a property often turns into desperation, forcing many borrowers to go to any lengths to buy a house – even if it means borrowing beyond their repayment capacity. “This is the most common cause of defaults by borrowers,” says Madan Mohan, chief credit counsellor at Disha Financial Counselling Centre. The borrower often falls prey to a loan component much larger than that necessitated by his repayment capacity due to the desire to own a larger house.

Taking top-up loans: Certain banks offer top-up loans to meet the cost of interior decoration and other expenses, along with home loans.

Many borrowers fall prey to such seemingly-exciting schemes, without realising that these loans are generally in the form of personal loans and credit card expenses, which are high-cost debts, putting a severe strain on their finances.

Acting on impulse: Home loans are sold on the basis of attractive offers. For instance, State Bank of India is offering home loans at the rate of 8% that can be availed of between February 2 and April 30, 2009. Borrowers stand to gain from this scheme for one year, post which the bank could revert to the market-linked rate, unless the borrower has availed of a loan under the packages announced earlier, that is, 8.5% for loans up to Rs 5 lakh and 9.25% for loans up to Rs 20 lakh, in which case the specified rates would be applicable.

While rates are the most important aspect, it would be unwise to make the decision solely on the basis of current considerations. After all, a home loan is a long-term debt with tenures often ranging from 10 to 20 years. Equated monthly instalments (EMI) that seem affordable at the moment may rise to unmanageable levels when interest rates start inching upwards.

Lack of awareness: The importance of reading the fine print of the home loan agreement cannot be emphasised enough. While going through the document suspecting dishonesty on part of the bank is unwarranted, it helps to know your rights and the bank’s obligations. “Once the bank agrees to sanction credit facilities, the borrower is given a written communication detailing the particulars of amount sanctioned, terms and conditions, responsibilities of borrower and the bank, etc. Borrowers must insist on such a sanction letter so as to enable them to take up the issue with the bank in the event of a breach,” advises VN Kulkarni, head, credit counselling, Abhay Credit Counselling Centre.

Also, borrowers need to be aware of the channels they can approach if they have grievances against the banks. Narrating an incident where a leading private sector bank’s conduct caused severe distress to a borrower, Mr Kulkarni says, “The terms were such that disbursement was to be made in stages as per the progress of construction and repayment was to start after 18 months of the first disbursal or completion of building, whichever was earlier. However, the bank disbursed the entire amount in the first month itself and started charging interest. Now, the borrower is in a spot of bother as he had planned to shift after 18 months and is finding it difficult to pay the rent as well as the EMI. We have advised him to approach the Banking Ombudsman.”

Source: Economic Times

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1 Comment so far

  1. Victoriamabel July 25, 2010 11:17 am

    Nice things shared in this blog “Six Home Loan Mistakes to Avoid”. This blog helps how to avoid mistakes in home loans. Very informative blog. Thanks for sharing.

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