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Lesser The Better

It’s better to have a lower home loan exposure in times of falling real estate prices.

The softening in real estate prices, which are now down in most places by as much as 25%, has not been the best piece of news for existing home loan borrowers. This is thanks to the “depreciation of security” clause that is mentioned in home loan agreements.

Simply stated, if the value of the property — which is mortgaged as security for a home loan — falls to below the outstanding loan amount, the borrower is required to pay the difference as a one-time margin amount to the bank. The other option is to provide additional collateral for the equivalent amount. If none of this happens, the bank reserves the right to seize the flat and a borrower, in turn, becomes an unenviable defaulter irrespective of his repayment record.

Let us take the example of a person who has bought a house for Rs 50 lakh. In line with the stipulated loan-to-value ratio, the bank cannot lend more than Rs 42.5 lakh. In today’s market, the value of that property drops by, let’s say, a quarter. The value of that house consequently is now Rs 37.5 lakh. Suddenly, the borrowed amount is less than the collateral, which leaves the bank with a situation where it can ask for additional collateral. This may be in the form of gold, property or any other asset. If none of that materialises, the borrower makes the margin money payment out of his/her pocket.

The way out for the borrower, according to experts, is to have higher home equity. Sujan Sinha, senior vicepresident, retails assets, Axis Bank, says that the clause becomes vital only if the bank has a higher equity component than the borrower.

“If the borrower holds substantial home equity component through his personal funding and pays EMIs regularly, then he will not be in a tricky situation,” Mr Sinha points out.

From the bank’s viewpoint, a borrower, who has demonstrated the ability to repay on time, is often the preferred one. “Usually they make some leeway for a borrower with a good payment track record. A disciplined borrower can negotiate with the bank for more time to pay the collateral/margin money,” says Amar Pandit, a certified financial planner.

The collateral issue has changed substantially over the past few years. Banks typically are mandated to lend up to 85% of the property’s value to the borrower. But that has often has been breached with past instances suggesting that the number could be as high as 95%. The borrowers did not have to bring in very much and, as a result, could easily stretch their finances.

Banks undertake valuation exercises for property that is under construction. According to an official at a private sector bank, “If the value (of the property) falls by 25%-30%, we revalue it, especially if we have lent up to 85% of the value. The idea is to ensure that the outstanding loan amount is lower than the property value.”

Interestingly, if a borrower approaches a bank today, he will get a lower loan amount, as the bank discounts the property value. “If a borrower approaches with a property value of Rs 1 crore, we evaluate it at Rs 80 lakh. This is not just in our interest but also augurs well for the borrower,” the banker added.

The crucial part is to ensure that the borrower does not go overboard. “A borrower should not increase his or her loan exposure even if it’s a home loan. A buffer should be created by borrowing only 50%-60% of the house value,” cautions Mr Pandit. Some food for thought for sure.

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