Chapter 4: Home Financing

Our HomeCapital experts have put together some of the things that you need to be aware while considering new home financing which are as follows.

Banks vs HFCs

Banks are not only the place from where one can avail of home loans. One can also get a home loan at attractive rates from something called Housing Finance Companies (HFCs). An HFC is a kind of a Non-Banking Finance Company (NBFC) solely into home financing for purchase or construction.

Regulation

Banks are regulated directly by the Reserve Bank of India (RBI). HFCs are regulated by the National Housing Bank (NHB), a subsidiary of RBI.

Funding of loan portfolios

Banks use the money deposited by their customers in their Current Accounts & Saving Accounts (CASA) to fund their lending of loans. It is the same money, which we deposit with the banks that is given as loans by the bank. HFCs, on the other hand, fund their loans by raising money from the public or by borrowing from banks. Since HFCs borrow from banks, the cost of funding for them is higher.

Therefore, we see that the interest rate charged by HFCs for home financing is higher than the interest rate charged by banks.

Interest rate methodology

Housing Finance Companies: HFCs’ interest rate on loans is based upon a rate called Benchmark Prime Lending Rate (BPLR) or simply Prime Lending Rate (PLR). HFCs use their costs of funds along with a certain profit margin to calculate the PLR. PLR is the maximum interest rate an HFC can charge to its borrowers. Most of the loans come at a Discount % on this rate. So, your effective interest rate is determined as below:

Interest Rate = PLR – Discount%

Banks: Banks determine their interest rates based on a rate called Marginal Cost of Funds Based Lending Rate (MCLR). MCLR is tenure-linked and is regularly published for different maturities, i.e. Overnight, Monthly, Quarterly, Semi-Annual or Annual. The base rate is the same for all the tenures. Banks charge a Tenure Premium to take into consideration the tenure-related risks & funding costs.

Interest Rate = MCLR + Spread

The spread will be determined by the riskiness of the borrower and the type of loan product.

Banks or HFC?

The advantages of home financing with banks are lower interest rates, long-term savings and transparent interest rate methodology. On the other hand, interest rates charged by HFCs are on the higher side. Usually, people who are refused a loan from banks approach HFCs as HFCs might consider any shortcomings with documentation. Moreover, they would be lenient with eligibility and credit score but will charge higher interest rates. They can sanction higher amounts as loan than banks for a given value of the property.

Fixed interest rates vs floating interest rates

Fixed interest rate loans are those where a borrower pays fixed interest and consequently fixed EMIs throughout the life of the loan. In such a loan, the rate of interest which a borrower pays does not change with the change in policy rates. The borrowers can be assured that as their income might increase over the period of time, their expenditure on the loan will be fixed leading to incremental future savings. This will give a borrower more control over the budget along with a sense of certainty and security. Thus, the fixed interest rates make future planning easier.

Floating interest rate loans are those where a borrower pays variable interest rates and consequently variable EMIs during the life of the loan. The rate of interest applicable will be dependent on the prevalent economic conditions and policy rates. Floating Interest rates consists of two components: A variable component such as 1Y MCLR and fixed spread over the variable; for example 40bps.

Floating Interest Rate = Variable Component + Fixed Spread

At any given point of time, your net effective interest rate will be determined by the current value of variable component (MCLR), which can increase or decrease over the period of time

If the prevailing rates go up, then a borrower will have to pay more interest and consequently more EMI per month. If the rates go down, then a borrower will have to pay less interest and consequently less EMI per month. Floating rates will make your future budgeting and financial planning more difficult. Any adverse economic conditions and monetary policy decisions can have a negative impact on your savings as you will end up paying more in EMIs.

Floating Interest Rates can bring you benefits as well. At the time of availing loans, the total floating interest rate offer is around 1 – 1.25 percentage points less than the fixed rates. Any favourable economic conditions and reduction in policy rates will further make you pay less EMI and save more.

To choose between a fixed loan or a floating one should be a well thought & carefully studied decision. You should consult your financial planner or home loan provider before making a decision. You should read the terms and conditions carefully to become sure that you are getting what you wanted from the home financing process.

Government schemes

Pradhan Mantri Awas Yojana (PMAY) – Housing for all by 2022 is a popular scheme launched by the Government of India launched in the year 2015. The ambition of this scheme is to provide a pucca house to every family in India with all the basic facilities such as water supply, toilet, 24/7 electricity and access to a home by 2022. The year 2022 has been selected because, in that year, India will complete its 75 years of Independence.

The scheme is classified into 2 segments:

1. Pradhan Mantri Awas Yojana- Urban (PMAY-U)
2. Pradhan Mantri Awas Yojana- Rural/Gramin (PMAY-G)

The Pradhan Mantri Awas Yojana-Urban (PMAY-U) was launched in the year 2015 and replaced the existing Rajiv Awas Yojana. The PMAY-U initially aimed at providing housing to people who came under the Economically Weaker Section (EWS) and the Low-Income Group (LIG) categories. The scheme now has been extended to include the vast middle class of India (Middle Income Group) whose growth is an important factor for India’s development. Now the families whose annual income is a maximum of ₹18 lakh can take advantage of PMAY-U.

There are four components of PMAY-U:

• Private developers participate by using land as a resource for the purpose of slum rehabilitation of slum dwellers
• Promotion of Affordable Housing through the Credit-Linked Subsidy Scheme (CLSS)
• Affordable housing in collaboration with private and public sectors.
• Subsidy for beneficiary-led individual house construction /enhancement

For a home buyer, the second component of the scheme that is Credit Linked Subsidy Scheme (CLSS) is of prime importance as it directly improves the home affordability. Under this scheme, the interest component of your home loan EMIs will be subsidised to some extent by the Government of India. “Credit-Linked’ means that the subsidy amount will derive its value directly from your home loan structure i.e. the loan amount, interest rate and the tenure. The subsidy amount will also be dependent on the size of the house purchased.

Under PMAY-U, a beneficiary family has been classified into 4 categories depending upon your income levels. The maximum interest subsidy you can get is determined by the category your family falls into.

Family Type	Income Levels	Max Carpet Area	Subsidy Rate %	Max Principal	Max Subsidy
Economically Weaker Section (EWS)	INR 0 to INR. 3 lakh	60 sqm	6.50%	INR. 6,00,000	2.67 lakh
Low Income Group (LIG)	INR 3 lakh to Rs 6 lakh	60 sqm	6.50%	INR 6,00,000	2.67 lakh
Middle Income Group 1 (MIG 1)	INR 6 lakh to INR 12 lakh	120 sqm	4.00%	INR 9,00,000	INR 2.35 lakh
Middle Income Group 2 (MIG 2)	INR 12 lakh to INR 18 lakh	150 sqm	3.00%	INR. 12,00,000	INR 2.30 lakh

There is no limit on the size of home you can purchase or the amount of loan you can get. It’s just that maximum subsidy amount will be determined by the certain upper limits on your house size and loan amount depending upon which category your family falls into.