Loan pre-payments: Look before you leap

With inflation showing little signs of loosening its vice-like grip, the RBI raised its key policy rates again last week — the tenth rate such hike since March 2010. Borrowers are in for a double whammy. Along with a rapidly increasing cost-of-living bill, they may have to shell out more to service their borrowings too. With most loans these days being of the floating variety, banks and financial institutions are likely to pass on their increased cost of funds to borrowers, who have to brace themselves for higher outgoes or extended repayment periods, or both.

With an increased strain on the pocket, does it make sense for borrowers with surplus funds at their disposal to pre-pay loans? The psychological comfort of owning an asset free of debt, especially a big-ticket one such as a home, is undoubtedly high.

Doing away with the Damocles sword of the lender over one's head seems to have intuitive appeal. Particularly, when the interest meter on the loan is ticking away fast and furious. That said, it may not be prudent to rush into the decision without doing some simple math. Here are a few points to consider in the pre-close-versus-continue decision.

Can you deploy it better?

More often than not, interest rates on loans and those on deposits tend to move in tandem. What this means is while lenders begin squeezing out more from you on the loan, you too can possibly earn a little extra on your surplus funds. Check whether you can deploy your funds more profitably than by using them to close the loan. If the potential return from investing the funds is higher than the cost of the loan, it may not make sense to pre-pay. While making this comparison, it is advisable to consider returns from relatively safe investment options, such as bank deposits, PPF or bonds. And, importantly, make the assessment of both potential return on investment and cost of loan, on an after-tax basis.

Say, for instance, on a pre-tax basis, you could earn 10 per cent on a fixed deposit, while the rate of interest on your loan is 11 per cent. In such a case, the choice to pre-pay would seemobvious. But enter taxes, and the picture may change. Tax breaks available on some categories of borrowings, such as home loans, reduce the effective cost of the loan. Principal repayments on home loans are covered under Section 80C, which allows a maximum deduction of Rs 1,00,000, while interest payments are allowed as deduction up to Rs 1,50,000 on self-occupied houses and to the full extent on other houses.

For a person in the highest tax slab (30.9 per cent), who borrows a home loan at 11 per cent, the effective cost of the loan works out to around 7.6 per cent. The cost of the loan is reduced by around 3.4 per cent (30.9/100 * 11 per cent), thanks to the tax breaks. The higher the tax slab, the lower the after-tax cost of the loan. On the other hand, investment income may be subject to taxes too, which eats into returns. In the above instance, for a person in the highest tax slab, the after-tax return on the fixed deposit with a rate of 10 per cent is 6.9 per cent. In this case too, since the after-tax effective cost of the loan is higher than the after-tax effective return of the deposit, it may make sense to prepay the loan. However, if you consider an investment in PPF, which gives an 8 per cent tax-free return and is also covered under Section 80C (to the extent of Rs 70,000), then pre-paying the loan may not be such a good idea anymore.

In this case, you may be better off investing the surplus. The bottom-line is, make your decision to pre-close or not, based on the opportunity cost of the funds on an after-tax basis.

Pre-payment penalty

Another key factor to watch out for is the pre-closure penalty being charged. Several banks charge a penalty, which could vary between 1 per cent and 3 per cent of the amount being pre-paid, for settling a loan before its due date. This acts as a disincentive against pre-payment. Some banks currently do not charge a pre-closure penalty, if payment is made from the borrowers' own funds. However, if pre-payment is made by refinancing the loan with other banks, this waiver is not given.

The good news is that the RBI has repeatedly frowned upon pre-payment charges levied by banks, and the results are beginning to show. SBI, for instance, has waived off prepayment penalties on its loans. If other banks also take the cue, it will be a welcome step for borrowers, with one negative variable taken off from the pre-pay-or-not decision matrix.

Till such time this happens, don't hesitate to bargain with your banker regarding waiver of the pre-payment penalty. With interest rates rising, bankers would probably be willing to waive off these charges.

After all, they too would be on the lookout for funds to re-deploy at a higher rate. Another way to get around the pre-payment roadblock is through part-prepayment. Many banks do not charge pre-payment penalty for amounts settled up to a specified extent, say 25 per cent of the loan outstanding. A borrower may consider pre-paying the loan to such extent, and continue servicing the balance.

For borrowers intending to part pre-pay, it makes sense to do so in the initial stages of the loan. Under equated instalment loan repayment structures such as EMI, the interest component of the loan is much higher in the initial instalments than in the later ones. Since part pre-payment is adjusted directly against the principal outstanding on the loan, payment in the initial stages results in a significant reduction in the future interest outgo. A part payment at the later stages would be less beneficial, since the bulk of the interest would have been paid by then.

Target the big pocket-pinchers

This one is a no-brainer: If you have multiple loans, those which carry the highest rate of interest should be paid off first. Not all debts rank equal. Some are undeniably more detrimental to the borrower's financial health than others.

On top of this list are outstandings on credit cards, which carry exorbitant rates of interest and are a sure-fire way of falling into a debt trap. Before pre-paying relatively benign forms of debt such as home loans, make sure to settle higher-cost debt such as credit card outstandings and personal loans.

Emergency Funds

In your urge to liquidate debt, don't go overboard in cleaning out your bank account. Remember to keep a sufficient cash reserve (say, living expenses for six months), which will come in handy in case of emergencies such as layoffs and unexpected medical expenditure. There is little point in pre-paying a relatively low-cost home loan, only to go in for a costlier personal loan within a short period.

Source:- ( http://www.thehindubusinessline.com/features/investment-world/article2115944.ece )

Home Sales may Squeeze More...

...As real estate developers & bankers indicate increase in home loan rates yet again

A25 basis point increase in key interest rates by the Reserve Bank of India on Thursday is likely to further squeeze home sales across the country, some developers and bankers said, amid apprehensions that banks may increase home loan rates again. 

“Purchasing activity had already dropped visibly during the last tranche of interest rate hikes, and we will see a further drop in buyer interest now,” said Anuj Puri, chairman of property consultancy Jones Lang LaSalle India. Owing to the last 10 rate hikes by RBI, EMIs for housing loans have risen 25% to . 980 per . 1 lakh of borrowing, and consequently loan eligibility for homebuyers has declined 20%. “Housing finance companies have no wiggle room available and will necessarily have to pass on this 25 bps hike to the customer,” says Anil Kothuri, head of retail lending business at Edelweiss Group. 
Customers will now have to reconsider the size and locations of houses they wish to purchase and many buyers are expected to put off their purchases altogether till home prices come down and rates stabilise. 
“This is certainly bad news for existing home loan consumers as banks will certainly increase home loan rates,” said Akash Deep Jyoti, head of Crisil Ratings. For new home loan seekers, this will be big deterrent, not just because of the rate hike but also because of the frequency of the rate hike by RBI. “The only positive for a person who is looking to buy a home is the option he has, of buying or not buying. Existing home loan customers are stuck,” said Jyoti. 
Renu Sud Karnad, managing director of private sector lender, HDFC, is, however, of the opinion that this quarter percentage hike will not impact housing demand and loan off-take. 
Increase in policy rates push the cost of properties up as they increase the cost of funds for developers, who are already reeling under the pressures created by high input costs. “We then have to pass on the same to end user,” said Pradeep Jain, chairman of Parsvnath Developers. 
Some builders are hoping that this is the last rate increase by the central bank for 2011. “Any further increase will be debilitating for our sector,” said Sanjay Kabra, chief financial officer of the Sunil Mantri Group. 
Cost of funds for developers is already very high, ranging anywhere between 14.5% and 16%,depending on the credibility of the borrower, and banks have not been willing to lend to the real estate sector in the recent past. This has forced many developers to tap other sources of funds, which are much more expensive than bank lending. 
The situation is not likely to improve in the next few months as analysts and economists across the board expect the policy rate to be hiked by at least another 50 bps in FY12.


Source :- ( The Economic Times)

Are you eligible for a home loan?

Home loans are the most easily accessible means of funding support to purchase a house . To understand how you can ‘enhance' your eligibility to apply for a home loan, make a simple self-assessment. Here is how banks do it.

THE CREDIBILITY FACTOR

Credit appraisal is the process followed by banks to determine the borrower's ability to repay his loan and determine how trustworthy he is. A prospective borrower has to go through various stages of credit appraisal practiced by different banks.

The main factor commonly considered by banks before its decision to lend, is ‘proof' that shows that the borrower is capable of repaying the loan on time. For this, they will look into your income documents, personal credit history, current assets and liabilities, education, work experience etc.

Older banks and co-operative banks to certain extent rely upon an existing relationship or the previous experience with a bank client while deciding on eligibility. A common pattern they follow is the sanction of a loan amount which will be a fixed multiple of the annual income. However, the new generation banks strictly follow other distinct parameters.

The loan eligibility in this case may be calculated by applying Fixed Obligations to Income Ratio (FOIR). Most banks restrict FOIR to a maximum 45-50 per cent of the client's monthly income.

LOAN-TO-VALUE

Loan-to-value is also a factor in eligibility calculation. Banks finance up to around 80 per cent of the property value determined by the bank's evaluator. For those who have not yet decided on the property, there is an option to sanction an in-principle amount, which helps to know the amount a bank would be able to give out.

For businessmen, banks will analyse the financial statements to see how the business has been faring for the past 2-3 years considering the Income Tax returns, Balance Sheets and Profit & Loss Accounts (audited and certified).

Before deciding to sanction a loan, banks also look into your credit history for your record on existing loan repayments, mishandled accounts or delinquent credit cards. This can be checked through a database of past loans and repayments available with the Credit Bureau of India Ltd (CIBIL). Cross checking of the income with documents like bank statements or initiating credit verifications is also part of the process.

A couple of factors could lend to enhancing your loan eligibility:

Clubbing an income - The income of your spouse also can be considered towards eligibility if you apply jointly.

Increasing tenure - Higher EMIs reduce the eligibility for the loan. The longer the tenure is, less the EMI will be. So, opt for a higher tenure. Usually banks offer a maximum of 20-30 years tenure.

Additional income - Your salary income may not be the only criteria to consider. Any source of consistent additional income like rental income may also qualify. Expected rental income from the property and any performance linked pay can be considered to enhance your loan eligibility.

Step-up loans- A step-up loan is a loan wherein an individual pays a lower EMI during the initial years and the same is enhanced periodically on conditions put by the banks. This is made after factoring in the individual's expected future salary hikes.

Pre-closure of existing loans - Existing loans like car loans or personal loans may reduce one's loan eligibility. As per norms, only existing loans with over 12 unpaid instalments are taken into account while computing home loan eligibility. So, prepaying the existing loans in full or part will help expand your eligibility.

Employer-bank relationship - A lower interest rate will naturally increase your eligibility.

Check with the banks if there are any schemes where the bank is tied up with your employer. Banks usually categorise companies based on their profiles and offer different schemes that could get you special interest rates, processing fee waiver etc . People working in MNCs can usually wrangle favourable terms.

Always remember, taking too many loans will reduce your credit worthiness and increase borrowing costs. Keep your credit score in good shape. Good and steady repayments keep you out of debt problems and keep your credit profile in great shape to use the power of leverage.

(The author is CEO, BankBazaar.com)

Source :- Business Line 

Is there a housing bubble?

House prices in six cities have registered double-digit increases since 2007, similar to the US, Ireland and Spain.

Regulators across the world are beginning to realise there is a link between financial crises and real estate prices. Considering banks had a big role to play in the sub-prime crisis, regulators are now concerned about spiraling home prices in India too. While banks and home owners refuse to acknowledge that home prices are near bubble levels, data seems to suggest otherwise.

Analysis shows some six cities have seen home prices go up in double digits since 2007, indicative of a bubble. In fact, in the second half of 2008, after the global financial crisis had begun, prices corrected in some markets but home prices in Mumbai, Kolkata and Faridabad continued to rise.

The National Housing Bank (NHB) has been tracking home prices across 15 Indian cities since 2007. The NHB-Residex shows prices have risen in most cities over the last four years. Prices in Hyderabad and Jaipur are lower than 2007 base level. In Bangalore, prices have jumped 37 per cent in one quarter alone. The Bangalore index jumped to 101 in October-December 2010 from 74 in July-September 2010. In four years, indices have doubled in Kolkata and Chennai.

In a report, STCI Primary Dealer has compared the increase in NHB’s Residex with that of housing indices in other bubble markets like Ireland, USA and Spain. In US, Case Shiller Index gives the price trends across 20 US cities. In January 2000, the index was at 100.59. It doubled in April 2006, marking a compounded annual growth rate (CAGR) of 12.1 per cent. The index has declined 31.4 per cent since the peak. In Ireland, too, housing prices index was around 33.6 in 1996, which peaked to 139.4 in 2006, marking a CAGR of 15.3 per cent. Prices have declined since then.

So, how have prices moved in India? Out of 15 Indian cities, eight have seen double digit CAGR increases since 2007. Kolkata and Chennai have registered higher growth than cities in three bubble economies of Ireland, Spain and the USA. Faridabad, Bhopal and Mumbai are very close to Ireland average as well.

Compared to growth in US Composite 20 Index, growth is seen higher in six Indian cities — Kolkata, Chennai, Faridabad, Bhopal, Mumbai and Ahmedabad. Clearly, double digit increase in home prices is indicative of a bubble, and regulators need to take cognizance of this, before it’s too late.

Source :- ( http://www.businessstandard.com/india/news/is-therehousing-bubble/437489/)