A Comprehensive Guide on How Home Loan Works

If you’re unsure about how home loans work, our comprehensive guide will help. Discover traditional and alternative paths to homeownership, including repayment terms, loan features, application steps, and home loan types. We’ve simplified the process to provide easy access to information, resulting in a clear home loan journey.

What is a Home Loan?

A home loan, also known as a mortgage, is a secured loan that allows you to borrow money from a bank to buy a home. Home loans can be used for purchasing an existing property, building a new one, or refinancing your existing loan. Usually, you repay the loan through monthly installments with interest, spread over 20-30 years.

How the Home Loan Process Works in India?

• In India, the home loan process begins with a financial assessment and research, followed by a lender’s application and review of creditworthiness, income, and property information.
• Property valuations and legal verifications are carried out to ensure that the loan amount and requirements match. Loans are approved and disbursed, with monthly repayment plans and no dues certificates.
• Before taking out a home loan, consider factors such as disposable income, down payment, and interest rates. Banks typically assess 50% of the applicant’s income for repayment, though additional fees may apply.
• Borrowers receive annual statements from lenders that detail their home loan transactions, including interest and principal payments.
• Borrowers can also make partial prepayments to reduce outstanding principal, which lowers interest payments over the loan’s term. This flexibility enables strategic loan management and may shorten loan tenure, allowing borrowers to effectively manage their finances.

How Does a Home Loan Work in Terms of Repayment?

Home loans have two main types of repayment terms:

• Principal-and-interest repayments: The principal-and-interest home loan requires borrowers to repay the borrowed amount (loan principal) and the associated interest charges, resulting in higher monthly repayments. While these payments are high, the advantage is that borrowers are actively reducing their debt, resulting in lower overall interest payments in the long run.
• Interest-only repayments: Interest-only repayments in the early stages of a loan provide a temporary break from principal payments, allowing you to focus solely on interest charges. However, this strategy increases overall loan costs over time as principal repayment becomes necessary, extending the period of interest payments.

Interest-only investment loans benefit investors and landlords because they are tax deductible, allowing mortgage repayments to be solely interest-based. This strategy helps to manage and reduce mortgage costs. Homeowners also used it during difficult times, such as job loss, increased expenses, or temporary financial changes, to provide temporary relief by focusing on interest payments.

Home Loan Features

Extra Repayments

Increasing your monthly repayments can lower your loan’s interest rate and shorten its payoff time. Initially, most repayments primarily cover interest, but additional payments directly reduce the principal, resulting in lower interest charges. Variable rate home loans typically allow for additional repayments without penalty, allowing borrowers to speed up payoff and significantly reduce total interest payments.

Offset Accounts

An offset account is similar to a regular transaction account linked to your home loan. You can make deposits and withdrawals with any other standard account. The primary benefit is that having money in this account can reduce the interest rate on your home loan.

The more money you keep in the account for a longer period of time, the less interest you’ll have to pay. This may help you pay off your loan faster. The offset feature is typically found in variable-rate home loans, but some lenders also offer it with fixed-rate home loans.

Redraw Facilities

A redraw facility allows you to retrieve any additional payments you have made on your home loan. Only funds higher than the required minimum repayments will be available to those who make weekly or fortnightly direct debit payments. Most bank variable-rate home loans include a redraw option, and there are no fees for using it.

Split Facility

A split loan divides a home loan balance into two accounts, with one set to a fixed interest rate and the other to a variable rate. This balanced approach allows you to customize your home loan to your specific financial goals, choosing between flexibility with variable rate repayments and stability with fixed rate repayments.

Things You Should Keep in Mind Before Applying for a Home Loan

Your Borrowing Capacity

When applying for a home loan, avoid choosing a higher loan amount just on increased income. Understanding your borrowing capacity is critical. Subtracting your monthly expenses from your income results in the amount available for monthly EMI payments on your home loan.

Credit Score

A credit score of 750 or higher is critical for obtaining favourable rates because it indicates a less risky borrower to lenders. A high credit score appeals to lenders, increasing the probability of receiving lower interest rates.

Loan Tenure

When assessing home loans, which often have tenures of more than 20 years and up to 30 years, it is critical to analyse the loan term and determine its suitability for your financial situation.

The Terms and Conditions of The Loan

The terms and conditions of a home loan agreement are legally binding, indicating your acceptance and adherence to the bank’s requirements. However, it is critical to understand that lenders may include restrictive instructions in these agreements.

Steps to Avail a Home Loan

Applying for a Home Loan

• The home loan application process involves submitting a formal application to a bank, followed by providing personal information for loan eligibility assessment.
• Banks typically require various documents such as identity, address, age, education, employment, bank statements, income, PAN card, and property details.

Payment of Loan Processing Fees

• Home loan applicants are typically charged a non-refundable loan-processing fee ranging from 0.5 to 2% of the loan balance, which is subject to 18% GST.
• Banks use this amount to start and maintain loan processes. Some banks provide exemptions as incentives, so, negotiations are based on individual bank policies.

Applicant’s Scrutiny and Verification

• The bank evaluates loan applications after they have been submitted and processing fees have been paid. A personal meeting with bank officials is typically required within 2-3 working days to assess repayment capacity.
• The bank then verifies all of the information provided in the application, including a credit history check using CIBIL records.

Evaluation of Repayment Capacity

• The home loan process includes verifying the borrower’s repayment capacity, which is critical to the bank’s decision to approve or deny the loan.
• If a conditional sanction is issued, all conditions must be met before the loan can be disbursed, ensuring a thorough assessment of the borrower’s financial capability and compliance with the bank’s terms.

Home Loan Offer Letter

• During this stage, the bank creates an offer letter that includes important information such as the sanctioned amount, applicable interest rate (fixed or floating), loan tenure, mode of repayment, any special schemes, and loan terms and conditions.
• To accept an offer letter, send a signed acceptance copy to the bank. This serves as a duplicate of the offer letter and is recorded in the bank’s records. Pay any administrative fees made at this time.

Property Verification

• Before issuing a loan, the bank thoroughly verifies the property, requiring original documents such as the title deed and no objection certificate.
• Under-construction properties are evaluated based on their location, construction progress, and quality.
• Age, ownership, construction quality, maintenance, location, and legal clearances are all considered when determining whether a property is ready for sale.
• The property is used as collateral for the secured home loan, and documents are returned only after the loan is repaid.

Home Loan Disbursal

• After completing all of the necessary steps, the home loan registration process begins. Legal documents are prepared based on the bank’s approval, and you must provide post-dated cheques and sign the loan agreement.
• Once this is completed, the bank will give you the loan amount based on the agreed-upon terms, either all at once or in stages.

Different Types of Home Loans in India

Home Loan for the Purchase of Land

Home loans are designed for individuals who wish to buy a residential plot of land and build their homes. The loan focuses on securing a plot of land for residential development.

Home Purchase Loan

Home loans for ready-to-move-in homes are intended for borrowers who want to purchase pre-existing, fully constructed, and ready-to-occupy properties. These loans are available for both newly built and resale properties.

Home Construction Loan

A home construction loan is a suitable option for people building their own homes. It distributes funds in stages based on construction progress and requires detailed timetables, plans, and budgets.

Home Extension Loan

A home extension loan is offered by banks to individuals looking to expand their existing residential property. It aims to enhance living space by adding extra rooms or floors.

Benefits include increased living space, comfort, property value, personalization options, avoiding relocation costs, tailored financing, and potential tax benefits.

Home Improvement Loan

A home improvement loan, also known as a home renovation loan, allows homeowners to finance repairs or renovations to their current home. This loan is suitable for both major and minor changes, including kitchen, bathroom, and flooring upgrades.

Conclusion

What is a home loan?

A home loan, also known as a mortgage, is a secured loan from a bank that allows homeowners to purchase, build, or refinance their home in monthly installments.

How does the home loan process work in India?

• In India, home loans are subject to a financial assessment, lender application, property valuation, and legal verification.
• Banks typically assess 50% of the applicant’s income as repayment.

How does a home loan work in terms of repayment?

Home loans have two repayment options: principal and interest or interest only.

Home loan features

• Extra Repayments
• Offset Accounts
• Redraw Facilities
• Split Facility

Things you should keep in mind before applying for a home loan

• Your Borrowing Capacity
• Credit Score
• Loan Tenure
• The Terms and Conditions of The Loan

Steps to avail a home loan

• Applying for a Home Loan
• Payment of Loan Processing Fees
• Applicant’s Scrutiny and Verification
• Evaluation of Repayment Capacity
• Home Loan Offer Letter
• Property Verification
• Home Loan Disbursal

Different types of home loans in india

• Home Loan for the Purchase of Land
• Home Purchase Loan
• Home Construction Loan
• Home Extension Loan
• Home Improvement Loan