The repayment of housing loans is through equated monthly instalments (EMIs). Some banks provide an accelerating or step-up EMI facility to borrowers. The step-up EMI facility intends to reduce the repayment burden in the initial years and helps in increasing the loan eligibility of the borrower. The facility helps young borrowers particularly. They prefer borrowing early but at the same time do not have high incomes and can't afford higher EMIs in the initial years. However, over time, as their income increases, they can afford to pay higher EMIs.

In this facility, the EMI portion is recovered in parts. During the first few years, a lower EMI is to be paid by the borrower. During the latter part of the loan tenure, the EMIs are increased, so that a higher EMI is payable during the later years. This way the burden of repayment in the initial years is reduced for the borrower.

The step-up facility involves a lower outgo in the initial periods. Borrowers who are likely to earn more in future can avail this facility to get higher loans and adjust their cash flows over a period of time. In this process, the borrower takes on a higher interest rate risk if the loan is based on a floating rate of interest. A rise in rates would mean that a portion of the interest would remain unrealised and added to the borrower's principal.

Since a large part of the initial instalments go towards interest payments, the borrower can avail of tax benefits for a longer period. Interest on the loan is a cost. However, tax benefits reduce the cost of borrowing. This way the borrower can deploy his savings in other investment schemes.

The principal repayment under the step-up loan may start immediately, thereby reducing the interest rate risk for the borrower. In other cases, the EMIs for the first few years are just enough to cover the current interest rate. The process of step-up can be in different phases. In some cases, two phases are offered - one at a lower rate and the other at a higher rate. In other cases, the step-up can be a gradual process. It can be done yearly, every five years or some other frequency. Some banks also offer the step-up facility with a fixed interest rate, but the rate of interest on such loans is higher than that on a floating rate loan.

The borrowers need to understand that in the step-up facility, the interest rate risk exposure is quite high. In the initial years, the interest component is more and the principal component is less - lower EMIs in the initial years would mean that lesser of the principal is being repaid. This deferral of principal to the later part of the loan tenure will increase the interest cost of the loan. This may turn out to be costly in case of a floating rate loan where the interest rate increases. The higher interest rate would have to be paid on a higher outstanding principal loan amount. In case of a rise in interest rates, the difference is recovered through higher EMIs towards the end of the loan tenure.

How a home loan’s tenure, interest amount and EMI are linked? Here is how....
The repayment of a loan taken to buy a house is made through EMIs (equated monthly instalments). EMIs are the fixed instalments which a borrower needs to pay over the tenure of the loan to repay the debt as well the related interest for the period to the bank.

Usually, the EMIs remain constant over the tenure of the loan. The loan amount plus the interest for the loan tenure, divided by the tenure of the loan (in months) gives you the EMI. The amount of EMI to be paid depends on and varies with the amount of loan, tenure of loan, and rate of interest. One of the important parameters governing the EMI is the tenure of the loan. Nowadays, you can avail loans for various tenures - between five and 20 years, and in a few cases upto 25 years as well.

Arriving at tenure

Here are two most significant factors that determine tenure:

1) Age: If you decide to borrow early, you can opt for a longer tenure loan - 15 to 25 years. This way, your monthly EMI payment would be less. Although the amount of interest paid would be higher as compared to other options, you can have the benefit of availing the loan for a longer period of time. However, if you are borrowing towards the end of your career, you may have to opt for a shorter tenure.

2) Income: This means both the present as well as the future income. You should be able to repay his EMIs without compromising drastically on your quality of living. The cash flows available after payment of EMIs should not entail a dent in the living standards. As such, a judicious planning of cash flows is required.

Tenure and interest

The longer the tenure, higher will be the interest rate. This is because of the increased risk the bank has to take. Also, the interest amount in absolute terms is higher, because of the longer tenure. However, the EMI is lower because the loan and interest are spread over a longer span of time.

The shorter the tenure, lower will be the interest rate. This is because of the relatively lower level of risk the bank takes. Also, the interest amount in absolute terms is lesser, because of the shorter tenure. However, the EMI is higher because the loan and interest are to be repaid over a shorter span of time.

Tax benefits

You should try to avail the maximum tax benefits available under the Income Tax Act. Presently, interest upto Rs 1.5 lakhs per annum paid on housing loans is deductible from the taxable income of a borrower. You should structure the housing loan amount and tenure so that your annual interest component paid in the near future is Rs 1.5 lakhs per annum. Of course, this would be contingent on other factors as well, like your annual income and savings potential.

Some conditions usually applicable to avail a loan to buy a plot of land

A loan to buy a site is available if you want to purchase a plot of land and construct a house on it later. Usually, the bank insists that the site be purchased from a recognised authority like a development authority such as the Bangalore Development Authority, from a society or from a recognised developer.

In addition to the normal documentation, some additional documents are required to avail a land loan. These include:

• Original documents of ownership of land
• No encumbrance certificate from the registrar's office certifying that the land is not already mortgaged
• Layout drawing (approved by the city development authority) of the location where the land is, giving details of the precise location of the site and its surrounding areas
• NOC from the society for sale and transfer of land Latest revenue receipt confirming payment of land dues to the government and tax receipt for tax paid by the owner of the land

Also, most banks finance the purchase of a site only if it is in a location within the limits of the municipal corporation.

Most banks have a minimum and maximum loan amount that they lend for the purchase of a site. This differs from one bank to another. Most banks specify a limit on the loan-to-value ratio that they maintain. It could vary from 60 to 70 percent of the registered value.

The loan amount offered has no relation to the market value of the property. Any premium paid by the purchaser has to be out of your own resources. Some banks charge a higher rate of interest on loans for purchase of a site. The rate of interest on these loans may be higher by about 25-50 basis points.

The disbursement of the loan amount is always in favour of the seller of the site unless the purchaser has already paid the amount to purchase the land. Typically, the charges applicable to normal housing loans are applicable to land loans as well. Further, the age norms for a customer to be eligible for a land loan and the eligibility calculations for computing loan amount are the same as that of a regular home loan. Most banks also have a minimum income criterion. The repayment for the loan is through equated monthly instalments (EMIs) just like other home loans .However, the tenure of these loans is usually lower – up to 10 years.

The interest paid on the money borrowed for the purchase of land is not eligible for income tax deductions. However, once the borrower converts the land loan into a housing loan to finance the construction of the house, he can avail the tax benefits available under the Income Tax Act.

The security of the loan is an equitable mortgage of the site. It is done by depositing the original title deeds of the site with the lender. The lender may also insist on additional collateral security depending on the type of land.

Financing purchase of sites is a bit risky because of difficulty in documentation. Further, there is risk of security of the property. This is compounded by the fact that there may be delay in commencement of construction. One necessary requirement is that the land should be developed and clearly demarcated, and should have been approved for residential buildings

Here are some home loan terms it helps knowing

CREDIT APPRAISAL

This is a process by which a lender evaluates the creditworthiness of the loan applicant. It involves assessing the borrower's past repayment history, establishing the sustainability of his current income and evaluating his capacity to repay. The applicant will be sanctioned a loan only after taking into account his savings, income, age, qualifications, period of employment and other outstanding debts.


EMI

EMI (equated monthly installment) is an unequal combination of two components - principal and interest. This is the amount of money the borrower owes the lender every month, through the tenure of the loan.


MARGIN MONEY

Also called down payment, margin money is typically around 10-15 percent of your loan amount. The bank does not disburse the entire cost of the property when you seek a home loan. It lends only around 85-90 percent of the project cost. The borrower is expected to bring in the remaining money. This is referred to as down payment or margin money.


HOME IMPROVEMENT LOAN

Some people may need money to repair, renovate, remodel or extend their home. Banks offer home improvement loans that you can use for making structural improvements, external and internal repairs, flooring, painting, improving plumbing, electrical work etc.


JOINT LOAN

A loan applicant can apply jointly for a loan with his spouse or parents. This way he can club the incomes. This increases his loan eligibility.


HOUSEHOLDER’S INSURANCE

This policy offers insurance for household belongings against fire, malicious damage, burglary and natural disasters like flood and earthquake. The householder's insurance policy is a comprehensive package that protects the house and its various contents against a variety of risks. It is a single policy that takes care of a number of contingencies.

Some tips to help you cope with higher EMIs without the risk of defaulting

Many borrowers, especially those who took a home loan when the rates were very low, are feeling the pinch of the higher rates prevailing now.

To understand the impact of the increase in rates on your Equated Monthly Instalments (EMI) outflow, consider this example. Five years ago, interest rates were at an unbelievable low of around seven percent. Suppose a borrower, takes a loan of Rs 50 lakhs for a tenure of 20 years, his EMI outflow comes to around Rs 39,700 at seven percent. For the same loan amount and tenure, consider the current rate of 13 percent. The EMI outflow comes to around Rs 58,500. If a borrower's income level has not risen up by this amount, then managing loan repayments becomes a tough task.

Here are a few tips that will help you cope with increase in interest rates:

• If you have money in instruments like fixed deposits or some surplus cash, consider prepaying partially. This way the increase in EMI outflow due to rate increase can be nullified.

• Consider paying off high interest debts first. Credit card penalties are huge. If your finances are simply unmanageable avoid using the credit card and transact in cash only.

• Rework on your budget if your incomes have stagnated and interest rates are shooting upwards. Make lifestyle changes and avoid high expenses.

• Consider refinancing if another lender offers a much lower rate. Some lenders who offer lower rates only to new customers and not to the existing ones must be avoided.

• Increasing the loan tenure brings down the EMI due every month to affordable levels. However, you pay more to the lender in the form of interest on the loan.

• Keep a tab on your monthly expenses, long-term financial commitments and other debts. Continue setting aside a small portion of your income towards a contingency fund.

• Do not indulge in debts.

Borrowers hold high emotional bonding to their homes. Defaulting is their worst nightmare. If you feel making EMI repayments an arduous task, contact your lender. You can try to workout a suitable repayment option and avoid defaulting.