Planning a home purchase budget – Home Loans: Everything You Want To Know

Almost every Indian believes owning a home is essential. But how do you decide the value of home that you can afford to buy?

How to plan a budget for buying a house?

When you think of buying a house in India, the options in front of you can be quite confusing

• Which town/city to buy
• Which area to start looking from
• How big should the house be
• How far are you willing to travel to work/school
• Whether you want to go with a known builder or a new one etc etc

For any financial decision, the most logical and long term method you should follow, is to start with a financial plan. A financial plan with starts with listing down all the sources of income. Then list down all your expenses – big and small. Extrapolate this to annual income and annual expenses. 

Now list down the financial needs you can expect in future, like education of your children, their wedding, purchase of car, vacations etc. Attach a value to each of these goals. Remember to account for inflation – i.e, future value of money. You can try this out on paper or just use an excel sheet. You can also add in the incomes and expenses of members of your household.

Now you will have a fairly clear idea of: 

• When and how much money you will have for down payment
• How much money you can comfortably spare for EMI 
• How long you can repay the loan 
• And finally, what is the value of house you can buy 

Pre Approved loans

Pre approved loans are a more recent phenomena. If you offer your income details,purely based on this, your bank can tell you an estimate of home loan amount you are eligible for. This is called pre approved loan. Technically you can take this letter to a builder as a proof that you are eligible for such a loan amount. 

What’s more, you can get pre approved loan sanction letters from multiple banks. All you will lose, is the processing fees at each bank. 

But a pre approved loan is based only on your income documents. It completely ignore the Loan to value. So the final amount of home loan you can get, could be much less. This is all right to go bargain hunting, but not practical when you want to plan a long commitment like Home loan. 

Advantages of a financial plan 

When you make a financial plan, you put a number to all your near term and long term financial needs. So before you start with the house purchase, you would know if you have some other big investment coming up in the next 1-4 years. You need to account for the near term needs first. The long term goals will be comparatively easier to take care off. 

Is there an ideal home loan amount?

Yes, there is such a thing. Here is is how you find out:

• What is your total income?
• Can your spouse or family add on to this income?
• What are you expenses?
• How much money do you have for down payment and out of pocket expenses?
• What are your other loan commitments?
• Finally, how much EMI will you be comfortable paying monthly?

All this information, along with the financial plan, will tell you how much home loan you can take. 

A rule of thumb, your total EMIs should be less than 50% of your net monthly income. That is, your EMI/NMI ratio should ideally be less than 50%. It could go up to 60-70% if your net monthly income amount is quite high. The assumption is that, at this rate, you will be able to take care of all your loans and expenses comfortably for a long time to come.

Banks also follow an acceptable grid of EMI/NMI ratio.  

What are the ratios that finally affect your loan value?

There are 3 main ratios banks assess: 

• EMI/NMI Ratio
• Fixed obligation to Income ratio 
• Loan to value ratio 

The first two ratios are similar. As the name suggests, the bank assesses if you will be able to pay your home loan comfortably over the next 10-15-20 years term. 

To know this, the bank will ask for a number of documents like your income proof, bank statement etc. You can understand the complete list of documents for salaried individuals and self employed on our previous posts. 

Loan to value ratio is basically the ratio of home loan to the value of the house you are buying. When you buy a house, banks prefer that you fund some part of it with your own savings. LTV acceptable to banks would be between 60%-80%. This is based on the value of loan, but banks are quite flexible with it. 

The grid of LTV and EMI/NMI ratios provide a guideline to banks. But finally there are a lot of factors that will be considered before a bank finalises the eligibility of a customer. 

What will be the bank’s look out 

Thank bank will see that you are borrowing within your means, that you can comfortably pay your home loan for many years to come. They will also check if your property can stand the test of time and if need be, can it be sold off to settle the loan. The bank doesn’t really plan to sell your property, but you should be able to sell if and settle the loan in the worst case scenario.

Read what are banks most concerned about when lending to self employed individuals 

So to get a home loan you want, keep an eye on these factors: 

• Try to maintain a CIBIL score of 700 and above
• Maintain records of all income
• Maintain consistent bank balances 
• Try to make sure all your income and outflow are routed through banking channels
• Apply for a home loan within your means 

Can you increase your eligibility?

You may have come up with the value of house you want to buy, but it is not always necessary the bank will give you as much loan as you want. What can you do?

You can enhance your home loan in a few ways: 

• Add a co borrower
• Show other incomes – rent, bonus, incentives, interest, dividend, agricultural income etc
• Pay more down payment etc

What should you keep in mind 

Remember these things : 

• A home loan is a very long term commitment. You should have thought out the cash flow for at least the first 5 years.
• You will find it easier to get a home loan if you maintain a good credit score and all your income proofs
• If you choose a builder who abides by all regulations, you will find it easier to get a home loan
• Be reasonable about how much down payment and EMI you can afford to pay comfortably
• Buying a house is not the be all – end all of your responsibilities. There are many financial requirements which will come up in future for you and your family. Be ready to take care of the essential needs first and then invest in a property
• Keep money for down payment and a few lakhs for costs that will not be covered by the loan

Now that you know what goes into planning for a house, go ahead and buy that house you have been dreaming about!