The mortgage crush

When Ambi Laxman, a government employee, took a home loan five years ago, interest rates were a mere 7.5 per cent per annum. The 40-year-old’s equated monthly installments (EMI) worked out to just Rs 806 per lakh for a 20-year term, and were easy on his wallet.

But the good times did not last for long. Interest rates began to rise and increased to 11 per cent per year. Ambi’s EMI wasn’t enough to cover his basic interest cost, let alone the principal repayment.

The bank called him to increase his installment. It’s a story that plays out across the country as millions of home loan borrowers struggle with their mortgage payments. “I have a large number of clients who borrowed when the interest rates were at or below 8 per cent,” says B. Raghavendra, Director, PV Money India, a mortgage sales agent. He explains how people invited this situation.

Borrowers often overlook the fact that in the first few years, a bulk of their EMIs goes towards interest and, in fact, barely clear 20 per cent of their home loan outstandings by the end of the ninth year.

When interest rates were low, many homeowners overborrowed, but are now finding it difficult to cope with the increased monthly instalments. “Those who borrowed at 7.5 per cent for 20 years are now paying Rs 226 more per lakh every month,” says Raghavendra. If you are among the many homeowners straining under the home payment budget, it’s time to get your finances in order.

Keep borrowing simple

HDFC Chairman Deepak S. Parekh blames complex structure home loan products for the trend. In HDFC’s annual report, Parekh notes: “Evidence has now shown that what works best for home loan borrowers are plain vanilla amortising loan products and not complex interest loans or exotic structures where interest rates are kept artificially low for the initial period, which then suddenly escalate to high floating rates. In most cases, borrowers rarely understand the risks involved in these complex products and invariably end up being stretched beyond their means.”

Stay ahead

As interest rates are rising, it’s also time to provide for the future. That trend might see homeowners defaulting on their home loans.

Besides, the Reserve Bank of India increased the repo rate, the rate at which it lends to banks, by 50 basis points on July 29 to 9 per cent.

Housing finance companies and banks, followed suit, raised rates twice in July 2008.

HDFC increased its floating rates to 11.75 per cent from 11 per cent last month. As home loan costs go up, so does the risk of an increase in defaults. “I fear that the default rate in the home loan segment may go up since EMIs have gone up,” says Prakash P. Mallya, CMD, Vijaya Bank.

Raghvendra suggests that borrowers can pay an additional EMI or two every year in the first few years of the loan tenure. “These additional payments will cut several regular EMIs later. Borrowers can use their incentives or bonuses to pay extra EMIs. Thus, they will reduce their liabilities with ease,” he says.

Prepayment helps

You can also prepay parts of the loan whenever you have excess cash. “Paying your loan even partly works well and the tenure drops dramatically,” says D. Timmana Gouda, Head (Retail Assets), South Zone of Axis Bank, Chennai.

The other side of defaults Just what could go wrong in the future, and how you can streamline your installments. What happens when a customer defaults? From March 31, 2005, an asset turns non-performing if an instalment is overdue for 90 days. If a borrower defaults for three consecutive months, financiers meet the borrower to ascertain whether there are any personal difficulties, like medical emergencies, unfortunate events like death, job loss, relocation from abroad, etc. Banks may be sympathetic if the house is occupied by the family and work out a payment schedule that suits the borrower. How can one catch up with EMIs? In home loans, penalties are not heavy, but EMIs pile up quickly. Borrowers can regularise installments by paying a lump-sum and reducing the outstanding balance. If the EMI is still a burden, borrowers can generate additional income through rent, etc. What happens if one’s house is notified? If the borrower is not willing to or is not able to regularise the account even after six months, the bank will allow him to find a buyer for his property at the price he wishes to quote and close the account by directly releasing the documents to the buyer on his authorisation and presence. Banks can also take action under Securitisation & Reconstruction of Financial Assets and Enforcement of Security Interest (SRFAESI) Act 2002 to recall your loan, issue demand notices of 60 days, issue and publish a notice, repossess the house and auction it for sale or lease or assign the rights, which will enable banks to settle their accounts and complete the process in about 100 days. Will they repay any excess amount after liabilities are met? Like in all “Repossess Asset to Recover” cases, banks are bound to account for all principal, interest, penal charges, legal charges of recovery, etc. After accounting for all the chargers, the excess, if any, will be refunded to the borrower. In case there is a shortfall, banks can initiate action to recover the dues in terms of the loan agreement.

Scale down plans

If you are a new borrower, your borrowing capacity will come down as interest rates increase the cost of borrowing. At such times, scale down your budget and go for a smaller house. On the other hand, special offers and deals have completely vanished from the market. But keep an eye out for loans cheaper than your existing one, suggests Srikala Bhashyam, Managing Partner of Bangalore-based RS Consultants, who advises clients on home loans, among other things. Banks come up with promotional offers at regular intervals, she says. Home owners should look for a lender who will offer you at least 1 to 1.5 per cent cheaper, and swap the old loan for a new one and thus save on interest. If the existing bank alone has any such scheme, it is better to clear the old loan and borrow afresh.

Assess your situation

You may not want to pay off your home loan too soon. Srikala advises people to check their tax deductions. “Don’t close your home loan as long as the annual interest component is Rs 1.5 lakh. A home loan is the only product that gives such high tax benefits.” At the same time, Srikala warns: “Don’t invest in property for the sake of tax benefits alone. Yields from property has come down and will remain that way for at least next one year.

How you can beat the heat 10 ways in which you can weather the storm. For existing borrowers When interest rates rule high, repay principal before tenure Divert other funds and clear your home from debts first Pay extra EMIs whenever you can. This will save you trouble later If you find your EMI steep, ask for extension of tenure from your lender Don’t close home loan as long as interest component is Rs 1.5 lakh. This will save taxes Always look for a new lender making a promotional offer. Retire old loan if new loan is cheaper by at least 1-1.5 per cent. If your present lender has any such offer, swap your existing loan for a fresh one For new buyers Be prepared to pay a higher EMI later as interest rates may go up further during the loan period Don’t invest in property only to avail of tax breaks. The amount needed for property investment has gone up substantially due to higher interest rates and high property prices Go for a house that suits your budget even if it means buying a smaller one Always go for a life insurance cover equivalent to your loan amount. This will ensure that your dependents are not burdened in the event of death

Property prices are now ruling stable in some markets and falling in many others. If you don’t have the ability to service the EMIs, don’t go for it.” Adds Prakash Mallya: “One should not borrow just because a loan is available; one should assess one’s ability to service it.”

Avoid defaults

As far as possible, avoid defaulting on your home loan. If borrowers default regularly, then, Timmana Gouda says, bank officials set up a meeting and try to understand the difficulties and work out another payment schedule. It may, however, invite a penalty. EMIs can pile up really fast and before you know it, you will be behind by a mile. You will have to make a bulk payment to catch up. Try and increase your additional income or rent a part of your house to ease the burden.

In a worst case scenario, banks will tell you to find a buyer for the property if you default regularly over a long period. Another option for the bank is to attach the property and auction it off. If the bank gets a price higher than the loan amount, the excess is refunded to the borrower. If the price is lower, the bank initiates legal proceedings to recover the balance from borrowers. It’s going to be a squeeze now, but if you follow these simple strategies, you will not wreck your finances.