Owning a property is often a financial resource people can rely on when times are tough. In these situations, obtaining a loan against property can be a viable option.
When you use your home, land, or commercial property as security for a loan, the money you request can be used for anything from growing a small business to repaying unexpected medical expenses. In this article, let’s look at the real issues that arise when a person borrows against their dwelling, office, or land. If you are considering it, here is what to be aware of.
How to Prevent Common Mistakes?
You are risking something valuable, often irreplaceable, when you take out a loan against property. Your property is collateral, which is a pledge of security for the loan, meaning that if you default, the lender is entitled to take possession and sell the property to recover the costs.
Before you apply, take a minute to look at the effective interest rate, processing fees, terms of foreclosure, and the actual payment after deductions. After you review it, you should avoid:
Overestimating Property Value
Let’s look at an example. You look at your flat and assume yours is worth Rs. 1 crore because your neighbour sold theirs for that. Therefore, you think you will get 70 percent of it as a loan.
But the lenders do not use your estimate. The LTV (or loan-to-value) ratio in India for a loan against property is typically from 50 percent to 70 percent, depending on the lender and the type of property. If the property is older or if the site is not great, the loan will be considerably lower. Thus, always check how lenders generally assess property before you apply.
Overlooking Hidden Costs
Many people think that the only cost involved in a loan is the processing fee. However, there are a number of other costs involved too (for example, legal verification, property valuation, reviewing, mortgage registration, and/or insurance), which can have a significant impact on the total cost of the loan. In addition, it may actually reduce the amount you will eventually receive on the loan, which can affect any financial planning if you were planning on the full loan amount.
Besides these main costs, it is also a good idea to check if your lender has any charges for foreclosure or part-prepayments. In some cases, lenders will charge you to pre-pay or to pay the loan early in case you suddenly come into a large amount of money and plan on paying off the loan. Therefore, to avoid all surprises, always check the lender’s fees and corresponding terms before you finally decide on a loan.
Skipping the Ownership Issues and Clarity of Title
Banks hold strict standards of evaluation regarding a clear title, a clean file, with no pending disputes, and within a determinate ownership status. Even the slightest technicality in the file could be the reason for your application’s delay. The worst experience is receiving a letter of sanction and planning your finances for expenditure, only to be informed at the last minute before disbursement that the loan will not go ahead due to one piece of paperwork. It happens more than you might think.
Get legal paperwork in order at the onset. If the property is jointly owned, get consent letters. If the property is inherited, check the mutation status.
Underestimating the Impact of Interest Rate Movements
Fixed rates are stable; floating typically have a lower starting point, but interest rates are susceptible to repo rates, inflation, and global fluctuations – especially in India. Play around with a loan against Property EMI calculator to see the impact of high interest rates before committing to the loan. For example, see what your EMI would look like for 1% & 2% increase.
Underestimating Existing Obligations
Your credit score might look healthy, but depending on your debt-to-income ratio and extension of existing obligations, it will typically remain a worry. Lenders will assess whether you will be able to make the new EMI payment on top of what you already owe.
This is where it can again help to use a loan against property calculator. While assessing your affordability, take your current EMIs into account. If your total outflow is above the 50-60% mark of your income, the risk of your loan being reduced/rejected increases.
Opting for the Wrong Tenure
Opting for a short tenure keeps your repayment lower but increases your EMI. Longer tenures may make the EMIs affordable but attract higher payouts. The ‘right’ tenure depends on how secure your income is, other commitments, and your outlook on life.
For example, if you are retiring in 10 years, you should not take a 15-year loan. If you expected a major expenditure in the next 3-5 years, like college fees, don’t overcommit in your smart loan against property calculator just to make it all fit now. Sometimes it is good to start with a medium tenure so you can prepay when those flush months arise.
Overestimating Your Repayment Ability
As an example, let’s assume the freelance designer gets to check the affordability of loan repayments using a loan against a property calculator. But three months after he secured the loan, he has two clients who have delayed, and he does not have the money to pay the EMIs. He is having to tap into his savings to keep up. Just because the calculator says the loan fits your budget does not mean you should go to the limits of the budget. When you are uncertain, ensure you have some breathing space.
Using the Entire Amount without Any Plan
Having access to a large amount of money can create a feeling that you have been compensated. However, it is vital to recognize that it is a loan secured against your property. If you are using it for a business purpose, be very precise with how the funds will be used and what types of returns you are expecting. If your use of the funds is for educational purposes abroad, consider how much is required for living expenses, consideration for currency fluctuations, and perhaps a backup plan. A medical need should prompt a question of whether you have exhausted all options before mortgaging your only property.
This money should not become a money ATM in case of an emergency. Once the funds are spent, the monthly installments are still due to be paid. If that obligation is not met, you will lose your property.
Not Following the Collateral Terms
The misconception is that a mortgaged property is still just a property. Many think they can renovate, sell, or lease the property without much consideration. In some cases, lenders can have terms in place preventing how a property can be used while the loan is still active.
It is vital to read the terms regardless of whether you think it is reasonable. If there is a term you do not understand, ask. Some premium financial service lenders, such as Godrej Capital, have had processes that protect both parties through specific terms and/or a digital application process. More than just protecting both parties by knowing the terms, you will save anxiety by dealing with a premium lender.
Final Thoughts
For a person who owns property, a loan against property is one of the best financial tools available. Of course, like all tools, it is useful only if you use it wisely. If you do it right, you can achieve your big goals without selling an asset. If you do it wrong, however, you may risk losing that important asset. Take the time to plan, ensure you understand your repayment ability, and that you understand every document you will be signing. If you are not certain, use a loan against property calculator so your decision is completely devoid of any guesswork.
Also Read: Negative Gearing, Depreciation, and Tax Strategy: The Accountant’s Guide to Property
