Home Loan Mortgage and Refinance
Like any real estate, residential real estate is also quite expensive. It is unlikely therefore that a homebuyer at any point of time has adequate savings to purchase a home suiting his or her needs. Most of these homebuyers opt to take home loans when purchasing a house. Since home loans are not small amounts, banks insist on some security, which has a value that covers the quantum of loan being granted. In general, banks agree to provide home loan, subject to a condition that the borrower creates a mortgage on the home being purchased with the loan. Such mortgage confers a right on the bank to liquidate the home and recover dues if any during the loan term.
Over the years, banks have done quite a lot of tweaking with home loans to make them suitable for a larger set of homebuyers. For example tenure for repaying the home loan has been extended to as long as 30 years, provided the borrower is young enough. In addition the concept of equated monthly installments (EMIs) has been introduced in home loans. There is no variation in EMIs throughout the loan tenure, even if the interest is to be calculated on flexible rates. If the interest rates climb, the tenure stands increased as do the number of installments, unless the borrower wishes to increase the amount making up the installments. If interest rates come down, the loan is repaid earlier, to which the homebuyer is unlikely to have any objections. Home loans and other loans obtained by mortgaging homes are also offered with fixed rate of interest. In such cases, there is no variation either in tenure or in EMI.
Each EMI is in fact a total of two amounts. One of these is the interest on principal outstanding at the beginning of the month, and the rest of the amount is towards principal repaid during the month. The principal outstanding stands reduced by this repayment of principal, and accordingly, in the following month, interest component in the EMI decreases, whereas the amount of principal repaid increases. Some banks even offered a moratorium period to homebuyers. Others let the homebuyers take a higher loan with part of it being repaid by any deposit or security that would be maturing during the tenure.
Homebuyer also has an opportunity to avail another mortgage on the same residential property, when the price of the mortgaged home increases. Since home loans are granted for a long period, the value of mortgaged asset invariably increases during the term. Generally, banks stipulate that such additional mortgage loan be cleared within the original term. Therefore, if a homebuyer took a home loan that was repayable in 20 years, then if he opts for a mortgage loan after 12 years, he will be liable to clear the new mortgage loan within a span of 8 years.
This type of second mortgage loan is often confused with home loan refinance. There are similarities between these two types of finance options available to homeowner.
The similarities are:
a. Both these types of loans are granted by creating a mortgage on residential property;
b. Interest paid on these loans is deductible as an expense against income from house property;
c. Both these types of loans are repayable over a long term;
d. Both these types of loans are repayable in Equated Monthly Installments;
e. In both these types of loans, presence of an existing home loan is a must;
f. These types of loans are generally availed to consolidate debts
g. The principal repaid on these loans is also eligible for tax rebates in some countries.
Differences between home loans refinance, and home loan mortgage are:
a. In refinance, the lender is generally a different bank, whereas homeowner gets the loan from the same bank on second mortgage or third mortgage;
b. The tenure for repayment increases in refinance, whereas the repayment term of loans on second or third mortgage is normally within the term of first home loan;
c. Refinance home loan is generally cheaper when compared to original home loan, or have the effect of lowering EMIs due to longer tenure, whereas loans obtained on second or third mortgages are granted at a higher interest rates than the original home loan, and the EMIs are consequently higher;
d. Refinance home loans are generally more affordable than second or third mortgage home loans as the EMIs are lower;
e. Since the lender is different in case of refinance of home loan, the entire process involved in obtaining home loans has to be redone. This includes obtaining a legal clearance, valuation of the property, checking the borrower's financial habits, and credit score, etc. Unlike this, in case of second or third mortgages, the bank already knows the borrower, and so also his or her financial habits. Moreover, the legal clearance of the first mortgage for home loan is valid for the second and third mortgages as well. Effectively, the processing charges are lower and the time taken to process such loans is shorter.
f. While assessing whether or not to go for refinance, the homeowner must also consider what will be the prepayment penalty that will be levied by the existing lender. In competitive environment, the banks tend to impose heavy penalties on prepayment of loans such that the interest rates on refinance almost come at par with interest rates that are charged on second or third mortgages.
g. Banks tend to aggressively refinance home loans when interest rates are falling all around. Unlike this, they concentrate on second or third mortgage home loans when interest rates start climbing.
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