“EMIs should not exceed 40-50% of your monthly family income” is the most widely accepted rule on thumb when it comes to budgeting one’s liabilities – especially home loans. But, there is a catch here. Indian banks follow a level-EMI repayment approach for loans, and this leads to an anomaly for a borrower, especially for young borrowers (age group 28-35). If his/her EMIs today are at 50% of monthly income, the EMI will continue at the same level till the tenure of the loan, even as the monthly income keeps growing in the later years.
This means the ratio of EMIs to monthly income keeps falling in the later years, and although this is a good sign, it comes at the cost of the borrower having to restrict the home purchase budget, during the initial years to a level which accommodates above EMI levels. In the later years, the individual then looks out for a bigger place to accommodate a bigger EMI without disturbing the ideal EMI-monthly income ratio. The State Bank of India (SBI) has come up with a solution to this.
SBI has launched a home loan scheme called as the SBI FlexiPay home loan. Under this scheme, the borrower has the option of paying lower EMIs during the initial years and to step-up the same in subsequent years, while ensuring recovery of the entire loan amount within the agreed tenor.
The bank said in a statement issued at the launch of the scheme, that the new offering would enable younger working professionals to get a bigger loan compared to their eligibility under normal home loan schemes.
Scheme Features
The applicant should be in the age bracket of 21 years to 45 years. The minimum loan amount under the scheme will be
Rs 20 lakh. The maximum amount would be 1.2 times the loan quantum calculated as per normal EMI ratio method subject to stipulated Loan-To-Value norms. The loan term would be minimum 25 years and maximum 30 years. The loan offers a moratorium period of 36 months for ready-to-move-in properties and a maximum period of 30 months for under-construction properties.
Scheme Analysis
Going by the press releases issued by the bank, it appears that this scheme is targeted towards salaried professionals who face difficulties in obtaining home loans on account of their incomes during initial years of their profession. Typically, salaried individuals are offered home loans to the extent of 80-85% of the property value, whereas for professionals, the LTV is restricted to approximately 50%. Under the SBI scheme, the professional can now expect to get up to 20% more than what would have been received under traditional home loan schemes.
It can be inferred from the scheme features, that due to the moratorium offered by the bank, the outgo towards the loan will be low in the first three years, which will later be increased moderately by SBI. However, the pattern for moderation in the EMIs has not been clearly specified by the bank as on date.
Peek into the past
An interesting precedent here is the case of teaser loans called SBI Flexi Home Loans, which were launched by SBI in 2009. Under this loan scheme, the interest rate was fixed at 8% for the first year and at 8.5% p.a. for the second and third years, respectively. Post completion of three years, borrowers had to choose either fixed or floating rates based on the prevailing State Bank Advance Rates.
This scheme translated into higher EMIs for borrowers at the end of three years, which, although clearly specified at the time of borrowing, had not been budgeted for by many borrowers. This resulted in some panic among borrowers, especially since there was a fair difference between the fixed rates and the State Bank Advance Rates. This scheme was also launched by some other institutions, but taking a cue from borrowers’ reactions, RBI had to finally issue directions to banks to close down these schemes in 2011.
SBI maintains that the new scheme cannot be characterised as a teaser loan as there is no discount in the interest rates being offered to borrowers.
Borrowers to be watchful
The scheme does sound like a win-win situation for the targeted borrowers, but it is important that the borrowers do their homework before taking the plunge. Borrowers should keep in mind and be prepared that the EMIs have the potential to go up 20-25% after the moratorium period. Three years or five years is a long enough time for individuals to easily ignore the expected hike in the EMIs and so they should factor this bit in their cash flow statement and financial plan. Expenses/ savings beyond five years should be adjusted to accommodate higher EMIs. During the period of moratorium, if the borrower comes across indicators signifying a flattish trend or even a drop in income for the coming years, adequate provision should be made to cushion the hike in EMIs.
Secondly, the scheme being a floating rate scheme, the borrower is also assuming the interest-rate risk, which will be more pronounced in this case. With higher rates, the bank may increase the EMI to accommodate the higher rates, thus leading to a double hike in EMIs — the planned hike and the rate increase hike.
If the working professional is able to hedge these risks from Day 1 of the borrowing by implementing financial prudence and discipline, then the scheme is a real boon. However, if the nuances are not understood clearly, the scheme has the potential for a high risk of default.
The author is a Proprietor at Arvind Rao & Associates, a chartered accountancy firm.