Buying a house has become easier these days, thanks to the changes in the policies of the Central Government and the resultant mushrooming of Housing Finance Companies (HFCs). The HFCs are literally hawking to woo the potential house buyers in order to boost their growth. Because of this, a variety of housing finance options is available to the consumers. However, for a layman, choosing a finance option is not as simple as the Direct Sales Agents (DSAs) of HFCs or banks make it out to be. There are certain facts, which are not always made clear to the client. To pick out a finance option that will give maximum benefits, you need to know the nitty-gritty of housing finance. Herein, we offer some important pointers that will equip you to make prudent decisions. Based on the following tables, charts and guidelines, it may be easier to figure out what is the best option.

What is the Best Option?

First, find out if the housing finance company offers Equated Monthly Installments (EMIs) calculated on a daily or monthly or annual reducing basis. Table I shows the calculations for a loan of Rs. 1,00,000/- for a 15-year period at various interest rates. Table I and Figure I clearly show that the daily basis of calculation is the lowest and the annual basis, the highest. So, if a HFC offers the three options, go for the daily option. Presently, most HFCs offer only the monthly and annual basis options. Here, one must insist on the monthly option, since the interests are calculated on a reducing monthly balance and not on an annual basis. But, some HFCs do offer a daily reducing balance option, which would be the best choice.

TABLE I - EMI / Lakh for Daily, Monthly, and Annual Rests (Reducing Balance)

Based on the income tax incentives provided in the past three budgets, one could plan applying for housing finance using the following methods. Obviously, go for the loan with the lowest interest rate possible. Depending on your repaying capacity and tax bracket and incentives, take the loan for the longest tenure possible for the lowest EMI. The EMIs drop faster when the tenure increases from 10 to 15 or 20 years, but the decrease is less as the tenure goes to 25 or 30 years. Table II and Figure II show clearly how EMI drops as the tenure increases.

But as the tenure increases, so does the total payments, since the amount of interest increases. There is a balance between the tenure and the EMI. Referring to Table III, one sees that at 10% interest rate for a 10-year tenure, the EMI and total payments will be Rs. 1322/- and Rs. 1,58,640/-, respectively. The total interest amount will be Rs. 58,640/- per lakh of loan taken. However, for the same loan, the total interest amount rises to Rs. 2,16,080/- per lakh over a 30-year period. The total amount paid back to the HFC more than doubles as the tenure period increases from 10 years to 30 years. It is very important that this is considered when one is taking a housing loan and planning the tax returns. Generally, the optimum period is around 20 years. Table III and Figure III show the total payments for different interest rates for various tenures.

TABLE III – Total Payments / Lakh, Tenure Vs % Interest Rates

Takeover/Refinancing a Housing Loan

Finally, when does one takeover/refinance an existing housing loan? The interest rates have fallen rapidly over the past three years and hence, one must always review the outstanding housing loans. Most HFCs are now waiving the pre-payment penalty. But many of them charge processing and administration fee of 1 to 2% of the loan amount. Table IV gives the savings over the tenure of 15 years for monthly reducing balance for a loan of one lakh for various interest rates. The reprocessing fee per lakh of loan is Rs. 2,000/-. But the savings are over Rs. 10,000/- per lakh, per percent of interest rate over 15 years. So, based on the terms of the housing loan, one should takeover/refinance the outstanding loan, if the interest rate is at least 2 to 3% below the existing rate. This will amount to saving of about Rs. 2,000/- per annum for a lakh. So, the saving in one year will cover the reprocessing fees itself. It is definitely worthwhile taking over/refinancing an existing loan as long as the new interest rate is at least 2% less than the interest rate of the existing loan. It will be wise to consult a tax advisor to ensure maximum benefits from a housing loan.

TABLE IV – Takeover of Loans, % Interest Rates Vs Savings

Clients may use the following checklist to get the best possible housing finance deal.