Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Module II: Credit Operations

Chapter 1(a): Retail Lending - Home Loans

Dr. R. Bhaskaran

Objectives

Provide general understanding of the need for retail credit, market size, product features,
processing activities involved and precautionary guidelines.

Structure

1. Introduction
2. General characteristics of retail loan products
Eligibility
Security
Loan amount
Margin
Disbursement and repayment
Interest rates and service charges
Annual percentage rate
Documentation
Recovery and collections
3. Retail loan products
4. Housing loans
Product features
Eligibility
Quantum of loan
Margin money
Repayment schedule
Interest rate and other charges
Security
Processing of housing loans
Disbursement procedure
Insurance
Collections
Takeover of housing loans

Page 1 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

1. Introduction

Banks extend working capital, term and other loans to corporates, partnership firms,
farmers, MSME, etc., for investment and business purposes. These are business loans
which lead to income generation for the borrower. Retail loans, on the other hand, are
provided to meet various personal and household needs of individuals. Retail loans are
small individual loans extended for purposes such as purchase of house or flat, vehicle,
consumer durables, making investments in the stock market, and meeting personal
expenses on medical emergencies etc. Credit card is an important component of retail
loans. Thus it is evident that these loans are not for productive or earning purposes.
Unlike business or farm loans, whose repayment terms are based on income generation,
retail loans are issued on the basis of borrower’s income and ability to set aside a portion
of it towards repayment.

Retails loans are popular among banks and customers due to a number of reasons. They are
appraised on a score card basis which can be easily developed by banks internally. Credit
scores help to classify the customer according to riskiness and arrive at a rate of interest
appropriate to their risk. A customer who scores a minimum threshold score is considered
for a loan subject to the following further conditions:

i. The due diligence includes KYC, income source and cash flow, details of assets to be
purchased and collateral if any. All of these are easily verifiable.
ii. Most retail loans are secured by a primary asset such as house, vehicle or
consumer loan and repayment from salary or other known income sources. As
such banks find it comfortable to lend in retail segment.
iii. The loan amount is a function of Loan to Value (LTV) Ratio of asset to be purchased
and/or debt service capacity measured in terms of Fixed Obligation to Income Ratio
( FOIR is calculated as a ratio of all fixed deductions including existing Loan EMIs and EMI of
proposed Loan to Gross Monthly Income). Banks and customers find this easy to adopt.
iv. Finally, banks can obtain credit information for a customer from the credit bureau.
Based on predetermined threshold score a customer’s eligibility can be decided.

Retail Loans therefore have features that address the financing needs of individual
borrowers and also impose certain conditions to be met by them. Retail loans are issued
subject to the condition that the loan amounts used only for the specified purpose for
which it has been sanctioned. The only exception to this is credit card dues and Loan against
property which can be used to meet a variety of purposes other than illegal or speculative.

It is seen that loans given to individuals and sole proprietors for purposes such as small
business, purchase of an asset (like a tailoring machine for instance), use of which results
in incremental income to the individual with which he/she repays the bank loan are
covered under retail segment by banks. The appraisal and processing of these loans are
different from the loans that are given for personal use such as home loans, vehicle loans

Page 2 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

etc. RBI classifies loans to individuals for non-productive purposes as personal loans1. For
the purpose of this unit, retail means all personal loans. However, as some banks cover
loans to professionals, small business, agriculture, etc., under retail segment these are
discussed, briefly in other chapters.

In the recent years, retail credit has seen explosive growth. This is due to several macro and
micro factors such as the robust and consistent growth of the Indian economy,
demographic dividend2 and increase in household income and growing middle income
group who have the purchasing power and desire to attain higher standard of living.
India’s middle class population has increased substantially during the last two decades.
Thus, consumer durables items like refrigerator which was considered a luxury around 10
years back has now become a minimum necessity. The same is the case with vehicles, air
conditioners, computers, etc. On the other hand, during the last couple of years, the
demand for incremental credit from corporate sector has declined considerably. Retail
loans are comparatively less risky, and help banks to diversify their loan portfolio. Given this
background, retail credit is an attractive avenue for banks.

The following table3 and chart gives the performance of banks in retail banks in India. It can
be seen that retail loans accounted for 21% of total loans (2017) and advances and that
housing loans accounted for more than 50% of retail loans. The steady growth in retail
portfolio that could be inferred from the table and increased number of loan products
demonstrate the importance of retail segment to banks and Indian economy. Companies
engaged in selling of retail products have benefitted from such growth.

Table 1: Retail Credit Outstanding with commercial Banks in India. Rs Billion

2012 2013 2014 2015 2016 2017
Consumer Durable 71 84 128 153 182 215
Against FD 570 613 641 629 723 680
Against Shares etc. 30 37 38 47 52 51
Credit card dues 204 253 249 305 469 649
Education loans 501 551 600 634 681 728
Vehicle Loan 892 1115 1304 1505 1543 1866
Other Personal Loans 1597 1777 1998 2376 2689 3355
Housing 4034 4622 5408 6309 7625 8530
Retail Credit RHS 7900 9405 10367 11958 13965 16074
Gross Bank Credit RHS 43793 49984 56572 61423 78965 81162

1
Basicstatisticalreturns:classification ofoutstanding creditof scheduledcommercialbanks accordingto occupation.
2
One of India’s competitive advantages is its demographic dividend. Demographic dividend occurs when the
proportion ofworkingpeopleinthetotal populationishigh. Thisindicates thatmore peoplehave the potential to be
productive and contribute to growth of the economy.: Arthapedia IEC
3
Report on Trends and Progress of Banks in India- various years up to 2016-17 RBI

Page 3 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Thousands

Thousands
2012 2013 2014 2015 2016

Consumer Durable Against FD

Credit card dues
Vehicle Loan
Housing

As observed earlier majority of the retail loans are secured loans. A secured retail loan is
one that is given by a bank to an individual on the security of an asset like house or vehicle.
A loan against fixed deposit is also a secured loan. Yet, there are certain retail loan
products which are not secured. For example, educational loan up to Rs. 4.0 lakhs is
generally without margin and unsecured. Banks may also grant some personal loans to
individuals without taking any collateral/security. Credit card payables beyond the initial
grace period attract interest. Credit card dues are, by design unsecured. Generally speaking,
secured loans are safe, in the sense, they easily recoverable. Yet collateral efficiency is a
function of effective legal machinery and procedures. Within the secured loans category,
gold loan is the most preferred one on account of easy marketability of gold even if it is in
the form of Jewels.

2. General characteristics of retail loan products.

Retail loans have certain typical features which are different from non-retail loans such as
business and corporate loans. In the following sections, the features of retail loan
products are discussed before discussing the specific instances of retail loan products.

Eligibility

Retail loans are generally given to eligible individuals. Different banks have different
eligibility conditions for offering retail loans. Common conditions are that
(i) a borrower must be an Indian citizen,
(ii) above 21 years (18 years for co-obligant) age at application, and below 70
years at the end of repayment.
(iii) Applicant could be an individual or a number of individuals (joint)

Page 4 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

(iv) They can be self-employed or professional having income tax returns.

Banks do offer some products under retail segment to Non-Individuals viz.,

Proprietorship and partnership firms, Private Limited Companies, LLPs etc., e.g., Loan
against Property

Accordingly, banks must obtain an application form. Verify KYC with reference to
Officially Valid Documents, verify the bank account, occupation, employer, income
certificate, dependents, etc. Details of bank account, credit cards, existing loans, etc., must
also be obtained to have information about the applicant’s financial liabilities.

Often banks require a guarantor to provide surety on behalf of the applicant. Details of the
guarantor need to be obtained in line with KYC and other requirements as mentioned for
the applicant.

In the recent years many credit bureaus have been established. Banks insist that a
borrower should have a good credit score.

Credit Score

Credit scores are used by credit card issuers, lenders, including banks providing home
loans, credit card companies, and Hire Purchase companies to decide on credit. Credit
score is expressed in number ranging between 300-850. Higher scores indicate
represent better credit worthiness and make bankers more confident that a borrower
will repay his/her debts as agreed. Generally, a credit score of 700 or above is considered
good. A score of 800 or above is considered excellent. Normally it is seen that most credit
scores fall in the range of 600 and 750. There are two major credit scores namely FICO
score and Vantage Score (developed by the 3 major credit bureaus including Experian,
Equifax, and TransUnion). There is no minimum credit score needed to apply for most
loans or credit cards. However, a person will not qualify for a loan or credit card and is
likely to get unfavourable terms of credit when the score is less. The following table gives
the details of credit score and possible treatment by lenders.
Credit Rating % of People who Impact: Possible outcome if a
Score have this level of customer has this score
score4
300- Very 16.7% Not likely to be approved for
549 Poor credit.

550- Poor 34.1% Lenders may approve credit, but

649 the rate of interest could be high

4
Esperian website

Page 5 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

and the down payments or

margin could be larger.

650- Fair 18.3% Lenders may approve credit but

699 rates may not be competitive.

700- Good 12.6% Credit will be approved if other

749 things are in order at

750- Excellent 30.3% Credit will be extended the best

850 rates and terms.

Information that would impact the scores are as under.

 Payment history (of the person for whom the score is sought) for loans and
credit cards, including the number and severity of late payments
 Credit utilization rate
 Type, number and age of loan and other credit accounts enjoyed by the
concerned person and the total debt outstanding against his/her name.
 Number of inquiries for credit report of a person which will reveal if the person is
trying to get too many loans.

Credit scores are not concerned with issues such as race, colour, religion, or marital
status. The report is gender neutral and does not discriminate gender. Similarly,
information on salary, occupation, title, employer, date employed or employment history
are not sought by credit bureaus. These are important for the lending
institution.

Security

Retail loans can be both secured and unsecured. A secured retail loan is one that is given
on the security of an asset like house, vehicle or fixed deposit. Security could be primary
which is the asset financed and collateral which is something more than the asset
financed. Unsecured or clean retail loans, (some of the educational loans and personal
loans) are granted by banks to individuals without taking any collateral/security.

Documentation is important. All details of the collateral such as its description, model or
specifications, ownership or title, market value, etc. must be obtained and the collateral
must be mortgaged or hypothecated to the lender before/ within a stipulated period from
the date of disbursal of the loan.

Page 6 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Loan Amount

The amount of loan is based upon the amount needed for the purchase of the asset and
therefore its market price. Accordingly, retail loans are sanctioned upon the original
invoice or sale deed. For unsecured loan, banks must assess the credit worthiness of the
individual to determine the loan amount.

Margin

As a rule, banks do not provide the full amount of loan to the retail borrower, who has to
meet a portion of the value of asset by way of margin money to avail of the loan. The
amount of margin, which is usually a percentage of the value of asset, is determined by the
bank based on certain regulatory conditions and internal policies. The loan amount after
the margin is generally above 70%. Margin is important to ensure the involvement of the
borrower in the asset and also to cover the gap at the time of possession and resale by the
bank. Margin varies from product to product.

Disbursement and repayment

Retail loans are of two broad varieties namely revolving or fixed-term loans. Revolving
loans provide a credit limit and the facility for withdrawal and repayment in any manner
and any number of times within the expiry period. The loan balance (outstanding) rises
and falls as borrowers withdraw amounts and make repayments. These are like cash
credits but not operated by cheque. Credit card is an example of such limit. Overdraft
accounts (given against financial securities/fixed deposits and overdraft against properties for
personal use are operated by cheque).

In the fixed-term loans such as vehicle loans and home loans, banks disburse a
predetermined amount of loan with instalment due dates (EMI payment dates) and
specific final maturity date at which time the loan is expected to have a zero balance. (EMI
has been explained in the home loan section). The borrower does not have the option of
obtaining additional funds under the original loan agreement. In the case of EMI based
loans, an amortization schedule is given to the borrower showing table of periodic loan
payments, broken down by the amount of interest paid and the principal to be repaid each
month from the first to last payment.

The source of repayment in retail loans is typically the borrower’s employment related /
business income. Therefore, repayments as EMIs are often linked with the borrower’s
salary account/ savings account through an electronic clearing service mandate.
However, the borrower may also choose to repay through any other mode. In case of
business people taking personal loans a mandate addressed to the bank is taken for
collecting or debiting EMI.

Page 7 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Interest rates and service charges

Retail loan borrowers are usually charged at the same rate for the loan category. This is
known as portfolio pricing. In such cases the risk of portfolio is passed on to all the
borrowers irrespective of the riskiness of individuals. Almost all borrowers are charged a
rate which is MCLR plus a risk premium. (MCLR applies in floating rate loans and will not
apply in case of fixed rate loans). This is because most such loans are smaller in size relative
to the overall portfolio and the information costs are usually high. Therefore, banks
restrict the amount of credit to the retail borrowers rather than offer price or interest
rate differential based on credit quality of the individual borrowers. Some banks may
finely classify the borrowers based upon their risk, such as by their CIBIL scores, and may
offer certain specific rates. Larger down payment for a loan may also lead to lower rates
as lenders can more easily forecast the cost of credit for a shorter loan period. Unsecured
loans may have higher interest rates. Banks may extend differential rates to senior
citizens, women or to customers under tie-up arrangements.

For a revolving loan, interest is charged on the balance amount in the loan account. In case
of a fixed loan, interest is calculated on diminishing balance over the period of the loan.

Retail loans are often associated with fees and service changes such as processing fees,
prepayment charges, delayed repayment charges, charges for conversion or switching
interest rates from fixed to floating rates and vice versa, charges for CIBIL report, charges
for CIBIL detect and commitment charges. These charges are product specific and may be
exercised in a discretionary manner. For example in case of home loans, banks may charge
for valuation of property from bank’s approved valuers, getting Title Clearance Report
from advocate on bank’s approved panel, registration of charges with the office of the Sub-
Registrar, stamping charges for execution of documents, premia for Insurance of
property/assets charged to the bank, CERSAI registration, etc.

Annual Percentage Rate

The "Annual Percentage Rate", or APR for a loan is the annual rate that is charged for
borrowing, expressed as a single percentage number that represents the actual yearly
cost of funds over the term of a loan. This includes any fees or additional costs associated
with obtaining the loan or incurred during the life of the loan.

Documentation

Retail loans are concluded through an agreement in writing between the lender and the
borrower.

The process of drawing the written agreement of terms and conditions relevant to the
constitution, facility and security along with payment of required stamp duty is called
documentation. Banks use well developed printed documents and the customer has no
choice with the words in the document or its content. The document mentions the amount

Page 8 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

of loan, purpose, rate of interest, rate of penal interest, percentage of margin, period of
repayment, amount to be repaid, rights of the bankers in case of default of loan, details of
security charged, fee and charges payable. Other most important terms and conditions
relevant to the sanction (MITCs) and general terms are included in the agreement.
Depending on the security, agreements could be pledge agreement, hypothecation
agreement, mortgage agreement, etc. Depending on type of loan, some documents would
be term loan agreement, clean loan agreement, guarantee agreement, etc. It is important
that the borrower understands the terms of loan and covenants of the agreement clearly
so as to avoid any dispute later. For this purpose, banks should give a full copy of the
agreement which include application, sanction letter after duly explaining the terms and
obtaining acceptance in writing from the customer, all agreements (properly filled and
signed) to the borrower.

Monitoring in Retail Loans:

The challenge in the retail loans is the follow up of huge volumes of accounts for continuous
monitoring and recovery. Once the disbursement stage is finished, assets duly charged and
title duly perfected, monitoring of the loan is required. Now a days banks use technology for
sending reminders automatically prior to due dates, dedicated back office and credit
monitoring cells and even assign the responsibility it to third party agents.
Recovery and Collection

Once a retail loans slips into default the recovery and collection function steps in. The
specialised department or bank will follow up for EMI immediately when the delay or
default is noticed. If their efforts fail and the account moves in to NPA category the
recovery efforts are taken by approved and certified recovery agents. Though these
agents follow and make collection there are many customer service related guidelines
such as when to contact a customer for collection and other DO’s and DON’Ts. The
collected sum has to be deposited with the bank on a daily basis and should not be used by
the agency for their own purposes. DRA should not delay collection because the incentive
or fee for collecting is higher as the default period is longer. An agent is not authorised to
offer concessions or misleading promises to the customer. Banks have a recovery policy
based on RBI’s broad guidelines.

If these efforts on collection fail bank has the option of adopting legal route for recovery by
filing suit. But this is not conducive as legal process is long. Recovery by enforcing security
under SARFAESI Act by banks is an effective tool wherever equitable mortgage has been
created.

If the amount is not collectible and dues cannot be collected banks can sell the loan to the
Asset Reconstruction companies. This will be for amounts much less than the
outstanding, but it helps banks to manage its retail portfolio.

Page 9 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

3. Retail Loan Products

In this section, we shall discuss briefly the following retail loan products.

 Housing loan
 Vehicle loans
 Personal loan
 Consumer durable loan
 Education loan
 Gold loan
 Loan against property
 Loan against securities
 Overdraft against salary
 Credit cards

4 Housing Loans

Housing is a basic human need. By and large, everyone will like to own a home and will be
willing to borrow to purchase or construct a dwelling unit. Besides providing economic
and social security, house is also an "asset" that can act as collateral for other borrowings
to support and supplement other means of income generation and poverty alleviation. It
has significant leveraging effect for the individual as well as the entire economy. Yet
affordability is a challenge in all emerging economies. Providing housing loans on
affordable terms requires long term funding support and innovative products.

Banks provide housing loans for a variety of purpose related to creation and support of
housing. The following are a few instances of purpose eligible for bank loan:
 Purchase of new or old residential unit

 Construction of a residential unit

 Repair/renovation of an existing residential unit

 Extension of an existing residential unit e.g. Construction of additional floor,

rooms, etc.

 Purchase of a non-agricultural plot of land for subsequently constructing a

residential unit i.e. a composite project.

 Purchase/construction of 2nd house/flat

 Completion of under construction residential unit. i.e. for a residential unit that is
half completed and the applicants have approached thereafter for a loan

 Purchase of solar power panel for installation in the residential unit proposed to be
financed by the bank. (However, home loan ‘only’ for installation of solar panel
cannot be considered.)

 Repayment of loan availed from other Banks/NBFCs i.e., takeover of housing loan
Page 10 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

 Supplementary finance:
a) Additional finance within the overall ceiling for carrying out alterations/
additions/repairs to the house/flat already financed.
b) In the case of individuals who might have raised funds for construction/
acquisition of accommodation from other sources and need supplementary
finance, banks may extend such finance after obtaining pari-passu5 or
second mortgage charge over the property mortgaged in favour of other
lenders and/or against such other security, as they may deem appropriate.

 Banks finance renovation of houses/homes as well.

Housing loan and priority sector norms

As per extant regulatory guidelines banks can deploy their funds under priority credit in any
of the three methods namely:
 Finance provided to individuals or groups of individuals including co-operative
societies is called as Direct Housing Finance. In contrast, loans given to Housing
Finance Companies, Housing Boards and other agencies, fall under indirect housing
finance.
 Direct finance: Finance provided to individuals or groups of individuals including co-
operative societies.
 Indirect finance: Term loans to housing finance institutions, housing boards, other
public housing agencies, etc., primarily for augmenting the supply of serviced land
and constructed units. Investment in bonds of National Housing Bank (NHB) or
Housing and Urban Development Corporation (HUDCO) or combination thereof.

Priority Sector Classification of Housing Loans:

 Loans to individuals up to ₹35 lakhs in metropolitan centres (with population of

ten lakh and above) and loans up to ₹25 lakhs in other centres for
purchase/construction of a dwelling unit per family provided the overall cost of
the dwelling unit in the metropolitan centre and at other centres does not
exceed ₹45 lakhs and ₹30 lakhs, respectively. The housing loans to banks’ own
employees will be excluded.
 Loans for repairs to damaged dwelling units of families up to ₹5 lakhs in
metropolitan centres and up to ₹2lakhs in other centres.
 Bank loans to any governmental agency for construction of dwelling units or for
slum clearance and rehabilitation of slum dwellers subject to a ceiling of ₹10 lakhs
per dwelling unit.
 The loans sanctioned by banks for housing projects exclusively for the purpose of
construction of houses for Economically Weaker Sections (EWS) and Low Income
Groups (LIG), the total cost of which does not exceed ₹10 lakhs per dwelling unit.
For the purpose of identifying the economically weaker sections and low income
groups, the family income limit is revised to ₹3 lakhs per annum for EWS and ₹6
Page 11 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

lakhs per annum for LIG, in alignment with the income criteria specified under the
Pradhan Mantri Awas Yojana.
 Bank loans to Housing Finance Companies (HFCs), approved by NHB for their
refinance, for on-lending for the purpose of
purchase/construction/reconstruction of individual dwelling units or for slum
clearance and rehabilitation of slum dwellers, subject to an aggregate loan limit
of ₹10 lakhs per borrower.
 The eligibility under priority sector loans to HFCs is restricted to five percent of
the individual bank’s total priority sector lending, on an ongoing basis
 Outstanding deposits with NHB on account of priority sector shortfall.

Banks have developed their own policies on aspects such as security, margin, age of
dwelling units to be financed, repayment schedule, etc. As mentioned above under
indirect financing, banks may finance construction activities (of individuals, cooperatives,
housing boards, etc.) leading to creation or supporting of dwelling units (construction of
educational, health, social, cultural or other institutions or centers, which are part of a
housing project and which are necessary for the development of settlements or
townships) are also covered under housing finance.

Product features

The housing loan product has several features that can be varying between bank to bank.
The following lists a few generic features of housing loans.

Eligibility

 Indian Citizen not below 21 years and not more than 70 years of age.
 Both salaried and non-salaried individuals who may be employed or self-
employed in business and have regular income whose amount and source must be
verifiable.
 Singly or jointly with other family members viz. father, mother, spouse, son, etc.,
(legal heirs) who have regular source of income.
 Legally competent individuals who are not close relatives can be considered
jointly for Home Loan, if the property is joint.

Quantum of Loan
(LTV Norms reference circular - RBI/2016-17/317/DBR.BP.BC.No. 72/08.12.015/
2016-17 June 7, 2017)

 Theoretically there is no ceiling on the quantum of loan for construction/purchase

of flat/ house. However, the amount of finance is decided by certain parameters
such as repayment capacity of borrowers and margin norms. As indicated

Page 12 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

previously banks use LTV and FOIR as two important criteria. Generally, it is seen
that banks adopted the lower value of LTV or FOIR for arriving at the amount of
finance.

LTV and FOIR and determination of Loan amount

RBI guidelines on LTV are as under.

For Individual Housing Loans

(i) Up to Rs 30 lakh: LTV of 90 `
(ii) Above Rs.30 lakh & upto Rs. 75 lakh : LTV of 80
(iii) Above Rs.75 lakh LTV of 75
(iv) Commercial Real Estate Loans to Housing Projects may be used for the
purpose of Housing Finance, but are not recognized for PS classification
and need not be discussed under Home Loan segment)

RBI guidelines state that to have uniformity in the practices adopted for deciding the
value of the house property while sanctioning housing loans, banks should not,
normally include stamp duty, registration and other documentation charges in the cost
of the housing property they finance so that the effectiveness of LTV norms is not diluted.

However, in cases where the cost of the house/dwelling units does not exceed Rs.10 lakh,
bank may add stamp duty, registration and other documentation charges to the cost of
the house/dwelling unit for the purpose of calculating LTV ratio.

Mr. Loan seeker wants to avail himself of a loan for buying a flat. The flat is 5 years old and
market value is Rs 50 lakh. Mr. LS has an income of Rs 90000 a month and a take home
salary of Rs 55000 after deductions for PF, Tax etc. As per banks home loan policy LTV
is 70% and FOIR should not be more than 50% of take home salary. The bank charges
8.35% interest and offers loan up to 30 years. If LS wants to avail the loan with
repayment of 20 years, at 8.35 %, 20 year loan will have an EMI of Rs 858.
Given the above the loan eligibility is calculated as follows:
 As per LTV will be Rs 35 lakh.
 As per FOIR, eligibility is calculated as 50% of take home salary is Rs 27510.
 Assuming he has no salary or other loan deductions, Based on EMI of Rs 858 per
lakh the loan amount on 50% of take home salary can be Rs 32.05 lakh. The
monthly instalments will be Rs 27500.
 The eligible amount for Home Loan sanction would be Rs 32.05 lakh

If the bank wants to lend Rs 35 lakh it will have to offer loan for about 26 years in which
case the EMI will be Rs 786 and the monthly repayment will be Rs 27516 slightly above
50% of take home salary.
In doing the above estimate bank can include the spouse income or co-obligant income
which can result in a higher amount of loan eligibility. In this case the total repayment
( interest and principle at the end of 20 years will be Rs 66.06 lakhs which means the
Page 13 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

interest amount will be Rs 34. 01 lakh. Interest rate is simple. This works out to an
annual average interest of Rs 8.35. (average loan outstanding will be about Rs 20.20
lakh and annual average interest Rs 1.69 lakh). The following graph will show how the
EMI will be adjusted. It can be seen that in the initial period almost entire EMI goes
towards interest.

A Graph on EMI payments for the above case is given below.

It can be seen that, in the initial years, in this case till 140th instalment a major portion of
the repayment is adjusted towards interest due. Banks charge interest and collect the
same on monthly basis.

 Loan for repairs/renovation may not exceed 75% of the cost of

repairs/renovation and the cost of the property after repairs /renovation
 In these cases, like that of home loan end use has to be duly verified
 Extension works e.g. constructing additional floor, rooms, etc. to be considered as
regular housing loan, the requisite plan approvals for the same to be held on
record.

While calculating the eligible quantum of loan, total cost can include:

 Cost of house as per agreement / sale deed

 Charges towards club membership, parking, fixed furnishing, etc. i.e. components
which will result in increase in the recoverable value of the house (provided
sufficient documentary evidence is available). It must be ensured that if these

Page 14 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

charges are already included in the cost of house as per agreement/sale deed they
need not be considered separately such that there is no double financing.
 Total cost will not include stamp duty, registration charges, VAT, service
tax/charges or any other charges which do not add value to the property or are
not recoverable on further sale of the property

Margin Money

Margin money is the amount of equity that a borrower must contribute to the loan. This is
arrived from LTV and could vary based on amounts and could differ from bank to bank.
Generally it could be:

 20% for purchase/construction for loans up to Rs. 75 lakh

 25% for loans above Rs.75 lakh to Rs.200 lakh
 35% for home loan limit above Rs. 200 lakh
 20% of cost or repair

Repayment Schedule

Housing loan must be repaid back within certain number of years.

 Maximum repayment period should not exceed 30 years for construction
/purchase of house/flat in case of floating rate loans and 10 years for repair
 Banks may offer moratorium upto 36 months in case of flats/houses under
construction. In case of ready to occupy house, there may not be any moratorium.
 Flip/Step-up/Balloon methods of repayments for the convenience of the
borrowers. Balloon repayments could be considered in case of borrowers who
have some loans which will be paid off in the known future. Once the loan is paid off
the borrower’s capacity to repay increases. At times banks market balloon
repayment in the hope of increase income say due to promotion etc. Balloon
repayment based home loans are more risky as the burden of EMI could double if the
initial low EMI period is longer. Also if at the time of reset if rates are increased the
EMI could be difficult to service. Balloon repayment coupled with ARM (Adjustable
Rate Loans or Mortgages) generally more risky than vanilla home loans.

Page 15 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Balloon Payment
A customer wants a larger loan but his current income does not sustain a larger EMI. In
such cases banks may offer a longer period of repayment or a balloon repayment. In a
balloon repayment initial EMI are smaller and EMI becomes larges after some time say
when the borrower reaches a higher level of income.
The word balloon points out to the fact that the later or final payment could be large and
has ballooned in comparison to earlier or previous payments. Balloon EMI payments
tend to be at least double the amount of the loan's initial EMI. Balloon loans are more
common in financing home loan builders than in retail home loans.
Typically, a Balloon payments loan could be packaged as two loans or two stage loan. In
the first stage a lower EMI or ROI is charged and the second stage the EMI and ROI is
revised. Accordingly the borrower pays a fixed EMI and possibly lower ROI for a
number of initial years, and at the end of that term, the ROI and EMI are reset and the
balloon payment rolls into a new or continuing loan at the prevailing market rates. In
these loans the reset process is not automatic. It depends on multiple factors, such as
whether or not the borrower has made timely payments and whether or not his income
has increased or remained consistent. If the loan does not reset, the balloon payment is
due.
In the above case if the borrower pays Rs 15000 EMI for the first two years then his
subsequent EMI will be Rs 30323 for the remaining 18 years it can be called balloon
repayment.

Interest rate& other charges.

Interest rate on home loan is arrived at portfolio basis taking into account cost of funds, cost
of operations, risk cost and banks profit margin. Risk cost could be the overall risk cost of
the bank or risk cost on home loan portfolio. In India, the regulator wants all banks to
adopt a marginal cost of lending rate (which the cost of mobilizing and lending one more
unit of fund). Once this is arrived at banks could add a risk premium based on the credit
score of the proponent/borrower. Banks may also some small concessions in ROI for
women. ROI could be fixed or floating. Of late most home loans are floating rate loans as the
rates are linked to MCLR.

In addition

i. Banks may charge processing fees

ii. No pre-payment penalty for self-closure.

Page 16 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Fixed and Floating Rate of Interest

Fixed rate of interest is one which does not change during the tenure of the loan. As
against this, a floating rate is one which varies from time to time say once in six months
or as agreed with the bank. In case of floating rate ROI will change with every EMI in case
of floating rate will change with every reset.

Floating rate is distinct from teaser rate home loans. In case of teaser loans bank will
offer a lower interest rate in the beginning say first two years to attract customers and
will increase it to a higher rate.

Both floating rate and teaser rate have implications for EMI and customers capacity
repay. Therefore these terms should be carefully explained to borrowers.

It may be noted that even in Fixed Rate of interest loans, Banks may exercise right of
resetting of interest once in 5 years as per their terms and conditions.

Security

Home loans are secured by equitable mortgage or simple mortgage of house / flat / plot
financed by the bank. These mortgages have to be notified or registered with the
Registrar of Assurances of the State.

Mortgages

The word “mortgage” in the context of a home loan means that the property being
offered as a security has to be mortgaged to the lender until the loan is fully repaid.
Mortgage is an agreement which entitles the lender to possess the property (physical
and legal) and sell or dispose the same to recover its dues.

There are many types of mortgages. In practice, banks use ‘registered’ and ‘equitable’
mortgages. Both these mortgages attract stamp duty and certain legal process. These
increase the effective cost of borrowing.

Equitable mortgage

In an equitable mortgage, the owner hands over the possession of title deeds to the
lender, thereby creating a charge on the property. The owner also orally confirms the
intent of creating a charge on the property. This intent is recorded by the bank in
writing but without the owner of property signing the same. In effect an equitable
mortgage is an implied or constructive mortgage. No legal procedure is involved in an
equitable mortgage. Yet, of late the fact of equitable mortgage is informed to the
Registrar of Assurances by way of memorandum of information (as per State laws). In
equitable mortgage the borrower has to submit his title deed to the lender as security
for the money borrowed. Equitable mortgage can be created only in notified towns and

Page 17 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

places. Stamp duty and charges are comparatively low, relative to a registered
mortgage. Equitable mortgage has to be registered with CERSAI within 30 days of
creation of equitable mortgage.

Registered mortgage

In a registered mortgage, the borrower has to create a charge on the property with the
Registrar of Assurances (land registry) through a formal, written and stamped
document as a proof of transfer of interest to the lender as security for the loan.
Registered mortgage is also known as ‘Deed of Trust’.

A registered mortgage meets all the necessary legal requirements to create a mortgage
or a charge. If the borrower repays the loan according to the terms and conditions of
the home loan agreement, the title of the property is given back to the borrower. The
rights of the lender (as created during the legal process) on the m mortgaged property
ceases when the loan is fully paid. However, if the borrower fails to fully repay the loan
(i.e. interest plus the principal component), the lender can take possession of the
property.

Generally, an equitable mortgage is considered easy and economical. The stamp duty
involved in an equitable mortgage is, normally much lower than that of registered
mortgage. The borrower and the bank representative do not have to visit the sub-
registrar’s office and undergo the process of registration/ release of the mortgage. The
original title deed is returned to the borrower without any formal process once the
debt is paid back to the bank.

Notwithstanding the benefits that equitable mortgage offers to both borrower and
lender, banks prefer registered mortgage because equitable mortgages lack records of
the loan on the property in the sub-registrar’s office. In an equitable mortgage, only the
lender and the borrower are aware of the mortgage/charge created on the
property/land. This leaves the possibility of the property being sold to a third party
without fully repaying the loan. It is for this reason that filing of a memorandum of
information with the registrar has been developed

Page 18 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Processing of Housing Loan.

Home loan process starts with a customer approaching a bank for loan either directly or
recommended by the builder of apartment houses.

The first step is to get an Application Form duly filled by the customer. The form will
contain details such as name, address, financial status of the customer, his take home
salary, etc. The customer will also fill up a Client Information Form as prescribed by the
bank. The customer will also give KYC documents for each applicant/co-
applicant/guarantor (if any).

i. Identity Proof – Aadhaar and PAN card are the most preferred ID proof. If a
customer does not have these two then other OVDs acceptable are Voter ID/
Passport/ Driving License/ Employer ID.
ii. Address Proof - Telephone Bill/ Driving License/Passport/Voter ID. If Aadhaar
contains address then there is no need for separate address proof. Whenever
Aadhar is accepted as an OVD for proof of ID/Address, written express consent to
be obtained.
iii. 3 passport size photographs of applicant , co-applicant and guarantor
iv. Office/ Business address proof
v. In case of salaried persons (a) Appointment letter / Offer letter from employer
(Salaried), (b) latest salary slip along with salary statement for the previous 3 to 6
months, Previous year ITR and Form 16 and bank statement for the last one year.
vi. In the case of self-employed (a) Income statement, (b) IT returns for the previous
three years, (c) ITR for the last three years and (d) balance sheet.

Bank will also seek credit score of the borrower and co-obligant, if any from not less
than two credit bureaus and satisfy itself that the borrower has good credit record.

Based on these statement bank will be able to arrive at the eligibility of the proponent,
his/her repayment capacity and the amount of loan that could be sanctioned. Bank will
also assess the customer’s capacity to meet the margin requirements and if he/she is
able to show the proof of fund availability. Then the bank will proceed with the appraisal
of the property and ownership. For this purpose, bank will need:

i. Property ownership documents: Title Deed/ Original Sale Deed/ Sale Agreement
/ Share certificate (s) issued by the society (duly registered) and other link
documents conveying the ownership. These documents could be different from
place to place. For example, there could be places where co-operative housing
societies may not be well established. In those places the documents will have to be
appropriate. The seller or vendor should have absolute ownership which will pass
on to the buyer (borrower) once the transaction is complete. Bank will seek legal
views on ownership, encumbrance etc. In the case of buying new flat the
agreement with be builder will specify the final value and instalments etc. In the

Page 19 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

case of ready flat or buying an existing flat the bank will seek a valuation
certificate. While the bank will not judge or advise on the price paid it will estimate
its loan amount based on valuation indicated above.
ii. Advance payment receipts/ own contribution receipts: In case of flats under
construction the borrower will have to produce the receipts for having paid
advance and other instalments as per agreement. In respect of buying a house
from others borrower has to give the receipt for the advance paid. It is also
important that borrower produces to the bank proof of funds available to meet the
margin or contribution.
iii. Copy of approved plan by local body: In case of a builder the agreement with the
buyer will contain the details of approval by the appropriate authority. In respect of
other purchases the borrower will have submit the plan approval document as
given by Municipal or Corporate town planning authorities.
iv. NOC from Builder/ Developer/ Society. These NOC’s serve the twin purpose of
informing builder, developer or society about the intended transfer of property so
that if they have any claim they can inform the bank. It also ensures that the title of the
vendor is clear.
v. Statutory and regulatory approval of construction proposed residential unit as
per state laws
vi. In case of construction/extension/repairs/renovations, estimated cost of
construction/ extension/ repairs/ renovations.

Disbursement Procedure

Based on the above the bank or lender will arrive at the bank loan amount, ROI and EMI and
communicate the same to the proponent in writing and in clear terms. The proponent or
prospective borrower will have to indicate his/her acceptance by signing the letter and
returning it to the banker. There after the bank/lender will

i. Reverify the KYC

ii. Execute the documents such as Promissory Note, Letter of agreement, equitable
mortgage etc.
iii. Bank will take post-dated cheques (PDC) for installments say 12 to be used in
case the borrower defaults in installments
iv. Letter from the borrower addressed to the bank giving standing instructions for
paying the EMI by debit to the account every month on a specified date (ECS
mandate)
v. Amount of premium for insurance, if stipulated
vi. Amount of margin or contribution from the borrower for the sale value
vii. In case of house under construction authority from the borrower for debiting his
account to the extent of margin or contribution.
viii. Bank will also visit the building under construction or to be purchased to verify
the genuineness of the property.
ix. Disbursement in the case of flat under construction will be made as per demand

Page 20 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

made by the builder which should as per agreement and stage of construction. In the
case of purchase of flat, the total consideration less advance paid by the buyer, if
any, will be paid to the vendor once the sale deed is executed and registered. In
case of housing society, the remainder of consideration will be paid on receipt of an
NOC from the society, acceptance to transfer the flat to the purchaser and
registration of sale agreement or sale deed. In case of society the borrower will
have to hand over the share certificates to the bank along with other documents,

Insurance

Most banks take a life insurance on the name of the borrower for an amount equal to the
amount of loan and get it assigned in banks name. This protects the borrower’s family in
the case of untimely death of the borrower and consequent inability to pay the loan. At the
same time there are a number of pronouncements from the regulator that such insurance
should not be insisted upon. These insurances cannot cover default and loss of loan on
account of death is not so well established. Insurance premiums are high and it could
substantially add to the cost of debt. Banks should explain the insurance to the customer
and get a clear and willing acceptance for insurance.

Collection

EMI for a loan for a flat under construction will commence on taking possession of the flat
or end of grace period as accepted whichever is earlier. Banks give moratorium period till
the time the builder has agreed to hand over the flat with occupation certificate. But there
are cases where the builder has delayed the construction and handing over of the flat and
hence banks stipulate an outer limit of period where no EMI is payable. The EMI amount
will vary if the flat is delayed and the interest for the moratorium period is capitalised.
Generally, interest is payable as and when debited during moratorium and it is not
capitalized with principal during moratorium period.

In case of purchase of flat the EMI can start immediately, or a period say three months
which will enable the buyer to get the house ready for occupation. Bank will debit the
customer’s account on due date every month and therefore the customer should keep the
account funded for the same. There could be default of home loans as also other retail
loans. The collection function in case of loan default is dealt in the last chapter under retail
loans.

Takeover of housing loan

In addition to extending loans for home loans through their own business development
efforts banks may also take over loans from other banks. Generally banks do not take over
NPA or defaulted loans. It is also seen that take over loans happen when the borrower
needs a higher quantum of loan or when the ROI of interest on home loans by the bank
taking over is lower than what is currently paid by the borrower to his/her bank. Also
takeover happens when the loans are changed from fixed rate to floating rate. No takeover
charge for floating rate home loans if the loan is closed on takeover by other bank / FIs or
third party sources.
Page 21 of 22
Course: Credit Management (Module II: Credit Operations) NIBM, Pune

If a bank takes over a housing loan from another bank the following additional documents
need to be obtained:

i. Original sanction letter from existing Bank / FIs

ii. Pre-closure letter with outstanding amount & NOC from existing bank / FIs
iii. Statement of loan account
iv. Sale deed copy
v. Latest valuation certificate
vi. Undertaking from bank/FI which is the current lender to directly send the title
deeds to the bank which is taking over the loan.

Banks are not permitted to charge foreclosure charges/pre-payment penalties on home

loans on floating interest rate basis by RBI to promote competition and convenience for
customers.

Page 22 of 22