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Misconceptions about home loans

Even as home loans play a critical role in helping millions of people own their homes, there are a number of myths that surround such home loans. Here is dispelling some popular home loan myths. When you understand what are home loans, you must also understand the basis for such myths and the truth behind them.

1. Always go for lower EMIs and lower interest rate loans

This is a popular myth about home loans. Is low EMI always good? Not necessarily. For example, the EMI on a 30-year loan will be substantially lesser than the EMI on a 20-year loan. But the longer tenure also means that you pay more as interest over the life of the home loan.

Secondly, is it true that lower interest rates are better? Broadly yes, but you should look at overall costs. Some banks offer you a lower rate to begin with, but the reset may not happen frequently. That means you are losing out when rates in the market fall. Also, some lenders may charge lower rate of interest but the prepayment charges may be exorbitant. Hence, look at the overall cost rather than just the interest cost.

2. There are no prepayment charges on home loans

The common myth is that when you repay a home loan there is no prepayment charge, since it only applies to unsecured loans. That is incorrect. Remember, prepayment is a percentage of the outstanding loan that the bank charges for closing the loan early. RBI regulations stipulate no prepayment charges only for floating (variable) rate loans. In the case of fixed rate loans, the bank is still free to charge prepayment penalty. Secondly, even in variable rate loans, bank can insist on minimum lock-in period and charge penalty if the borrower prepays the loan earlier. Banks can also put conditions like only 25% of the loan can be repaid in the first 5 years, with no restrictions after that.

3. A good CIBIL score is guarantee of getting home loan

A good CIBIL score of 750 and above helps get a home loan, but that is not the only condition. It is one of the factors. Apart from CIBIL score, the lender also considers factors like employment status, stability of income, age, job risk, professional qualifications, location of property, and valuation of property. A home loan is a back-to-back secured loan by hypothecation of property. Even if the CIBIL score is slightly lower and other factors are favourable, the borrower stands a good or even better chance of getting home loan.

4. If you prepay home loan, you lose tax benefits

The statement is technically correct, but conceptually wrong. Section 24 of the Income Tax Act proffers tax benefits on interest on home loan. The bulk of the interest is paid in initial years and later on it is more principal. If it is a 20 year loan, then bulk of the interest is paid in 10 years. At that point, if you have surplus cash, it makes sense to prepay and close the home loan. You get unfettered rights to the property and can improve your credit score.

5. RBI decides home loan interest rates

RBI only sets the repo rate in its monetary policy. Based on the repo rate, the banks set their own prime lending rate (PLR) based on their cost of funds; but close to prevailing market rates. Home loan rates can also vary depending on the creditworthiness of the borrower. The same bank can give home loan to one person at 9% and to another at 11%, based on credit standing and relationship.

6. It is best to take a home loan when you are young

When you take a home loan at a young age, you get longer tenure and pay lower EMI. But that is not the only issue. For most people; it takes some time to stabilize and decide on which city they want to settle in their careers. There is no point buying a home if you are going to move out later. It is best to wait for a few years and decide where you want to settle, before taking the home loan decision. It makes sense to stay in the home you build.

7. Fixed loans are more profitable than variable rate loans

That is not always true. When interest rates are falling, floating rate loans make more sense. Also, floating rate loans can be prepaid with zero prepayment charges unlike fixed rate loans. In fact, there is nothing like a truly fixed rate loan. There are protective clauses in the agreement by which your fixed rate loan will also see reset in interest rates if market rates go up sharply.

The bottom line is that when you get into the nuances of what are home loans, you must also spend some type understanding home loan myths and dispelling them.

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