A Basic Guide to Help the First Time Homebuyer with Home Loans
Buying your first property is a dream come true moment for everyone. It usually comes after years of hardworking and struggle. Buying a home is a lifelong decision, and it brings numerous equations to the table. Usually, we do not pay the entire cost of the home upfront. Rather we take a home loan and pay off the property in installments. However, the process of taking home for buying your first property may prove to be complex. If you are willing to apply for your first home loan, consider these essential factors before financing your first.
To be approved for a home loan for the first time, you need to meet several requirements. In addition, to be recognized as a first-time homebuyer, you need to meet a specific yet broad definition. A first-time homebuyer must not have ownership of a principal residence in the past for three years. However, one can be eligible as a first-time homebuyer if the person shares ownership of the property with a spouse.
The bank will further enquire you about your financial condition before confirming your eligibility. A first-time buyer must show proof of income for at least two years. The annual income must meet the cutoff line to become sufficient enough to pay off the loan. The bank calculates the DTI ratio (Debt to Income) before writing off the loan. The debt to income ratio is the ratio of the monthly loan payment to the buyer’s monthly income who is willing to take the loan. DTI is calculated in percentage. So, lenders such as banks are more eager to give the loan to people with a lower percentage of DTI as they are deemed less risky. You also need to show your tax information during your employment period. The overall wealth of the borrower will contribute to the final credit score as well. Lastly, the bank will check if you have any other ongoing loans.
Home loans are offered in two different types of interest rates. They are called fixed-rate interest and floating-rate interests. Home loan interest rates are also known as mortgage rates.
In a fixed-rate interest rate, the interest rate stays the same during the entire loan period. The benefit of a fixed-rate interest rate is you will have a clear idea of your monthly interest payment amount and the entire cost of the loan. However, it has a downside too. If the interest rate in the country falls, you will not be benefitted as you are locked in that interest rate. In addition, the bank sets a home loan interest rate for the first-time buyer based on the annual income of the person. But as home loans have a long tenure, the annual income of the borrower is likely to increase. Despite having a better credit score in the later years of the tenure, the borrower will not receive any deduction in the interest as the interest rate will remain locked in.
On the contrary, the floating-rate interest rate is flexible. The interest rate is never locked in. Rather, it varies depending upon the market rate and the credit score or the annual income of the borrower. Usually, the banks offer adjustable-rate home loans for five, seven, ten, fifteen years. The rate adjusts periodically, normally each month, depending on the change in the market rate. However, the drastic adjustment will not take place as the adjustment is capped.
The floating-rate interest or adjustable-rate mortgages are usually the best options for first-time homebuyers. First-time home buyers are usually at an earlier stage of their careers. As the years will go by, their annual income will increase substantially. The adjustable-rate will continue to adjust with the annual income of the borrower. Thus, the borrower will end up paying EMI at a lower interest rate in the later years and save on the interest expense. However, it is important to understand that the borrower can only enjoy the benefits of a better credit score if the market interest rate for home loans remains relatively stable. The adjustable-interest rate may become a bone in the throat if the interest rate in the market increases greatly with time. The borrower will then end up paying mortgages at a higher interest rate as the rate will adjust with the market rate. However, the borrower may end up paying far less in mortgages than the initially anticipated amount if the market rate for home loans drops.
Equated Monthly Installment (EMI)
Usually, banks will provide a home loan based on 50% of your monthly take-home income. You may enhance your eligibility by adding your spouse’s monthly pay. As mentioned before, the banks will set your interest rate based on your occupation, monthly and annual income, and credit score. But there is another factor that will influence the interest which you as a borrower need to choose. This is the tenure of the loan. The tenure is the total duration of the loan period. Banks offer up to 30 years of tenure to pay off the loan. However, as tenure impacts the EMI, you need to consider it thoroughly.
There are two basic rules of thumb. Firstly, the longer the tenure you choose, the lower will be the required EMI. Secondly, the longer the tenure you choose, the higher will be the total interest paid. In other words, if you take a loan for 30 years, you will be paying lower EMI than a 15 years loan. However, you will be paying more than twice the total interest paid.
To illustrate this scenario further, assume Mr. A takes a home loan of 35 lakh Taka at a 7% interest rate.
If the tenure is 15 years, Mr. A will need to pay an EMI of 31, 459 Taka.
Mr. A will pay a total interest amount of 21.62 lakh Taka when the tenure ends.
Now, imagine Mr. B taking a home loan of the same 35 lakh taka. But the tenure is 30 years.
For Mr. B, the EMI will be 23,286 Taka.
But the total interest paid amount for Mr. B will be 49 lakh, Taka, more than twice of Mr. A, at the end of his 30 years tenure.
Here, as Mr. B has a longer tenure, he is paying 26% less in EMI. Mr. B saves 8,173 Taka in EMI. But he ends up paying 126% more in total interest paid.
So, it is clear that the total interest you will be paying will greatly depend upon the tenure you choose. The longer the tenure you choose, the heavier the burden of interest you will need to carry. Hence, before finalizing your tenure, thoroughly think about the impact of EMI and total interest cost. Evaluate the factors that will help you choose the optimum tenure.
Purchasing a home comes with a series of additional expenses like parking charges, stamp duty, registration fees, brokerage fees, etc. Similarly, home loans have additional expenses as well. The banks may not disclose all these additional expenses initially with the actual loan cost. As a borrower of a first-time home loan, you may overlook all these additional expenses that come with each home loan scheme. These additional expenses include processing fees, legal and technical charges, GST, stamp paper cost, and so on. You must clearly ask the lender about additional expenses to calculate your effective cost of the home loan, which is a sum of the actual loan cost and the additional expenses.
Additional charges vary from bank to bank and often are not disclosed on the bank website. Hence, you may find it difficult to compare the effective cost of home loans of different banks. However, recalculating the effective cost may help you to figure out the additional charges. For example, assume you are taking a home loan of 50 lakh Taka with a repayment period of twenty years, and the total additional charges are 20,000 Taka. At a 7% interest rate, the EMI will be 38,765 Taka. As you are required to pay off the additional charge of 20,000 Taka upfront, the actual net loan will be 49.80 lakh, Taka. To further clarify, you will actually be paying an EMI of 38,765 Taka for a net loan of 49.80 lakh Taka, and it will push the actual interest rate to 7.05%, an extra cost of 5 bps. The comparison will be easier once you figure out the actual interest rate for all lenders. You should be wary of the fact that some banks will offer to waive the additional charges but be cautious of the fact that they are not charging the amount indirectly.
To buy a home on loan, the maximum you can borrow is 80% of the property value. The percentage is capped. The rest, 20%, is the borrower needs to pay from his or her own pocket as a down payment. For example, if you apply for a home loan for a property worth 70 lakh Taka, the bank will provide you with a maximum amount of 56 lakh Taka. The rest, 14 lakh Taka (20% of property value), is what you will need to pay as a down payment.
For a first-time homebuyer, a down payment may become a tough obstacle to achieving the dream of having a home. The down payment is the largest up-front expense while purchasing a home. Moreover, as the down payment is paid during the closing, it influences the tenure of the loan—usually, the less the down payment, the more the interest payment. Hence, the down payment plays a crucial part in determining the loan-to-value (LTV) ratio. The LTV ratio is calculated by dividing the total loan amount by the property’s market value. The larger the down payment, the lower the LTV ratio. A lower LTV ratio will directly influence the lender to bring down the interest rate. A low LTV will help to reduce the overall tenure of the loan as well. On the contrary, the higher LTV ratio will push the interest rate higher. A high LTV presents a risk to the banks. Because if you invest more of your own money as a down payment into the property, it represents your greater stakes into the asset. Hence, the banks will consider you as a more credible borrower as you are less likely to default and offer you a lower interest rate. On the other side coin, a high LTV means you have a lower stake in the property, and the bank will consider you as more likely to default on a loan.
For a first-time homebuyer, a larger down payment may not be available. However, it can be a smart strategy to take a home loan for buying your first property. A large down payment will lower both the EMI and interest paid overtime. It will further qualify you for a much lower interest rate. Finally, it will mean you have a greater stake in your property and will help you in future borrowings.
If you are taking a home loan to finance your first home, you are likely to find it difficult to sort through all the financing options and processes. You should take ample time to decide how much you can afford to pay as a down payment and how much monthly expense can you bear with your income. Consider the types of interest rate options and choose wisely based on your future financial progress and the overall forecast of the value of the housing market industry. Be aware of the additional expenses that come with a home loan which can increase your effective cost. If you can afford to pay a larger amount as a down payment, you will gain more negotiating power with the banks, and it will help you to substantially bring down overall the loan expense. The weight of a larger loan amount comes with longer tenure and total interest expense. While you may seek the help of a home loan broker to figure out the best option, only you can serve yourself better by knowing your priorities for a home loan.
Can I change my interest rate type in the middle of my loan tenure?
Ans: Unfortunately, no. Once you choose a loan scheme, you are bound to abide by the rules till the end of the tenure.
Can I take multiple home loans from different banks to finance the same property?
Ans: Yes. There are no legal barriers. If the banks find you eligible, you may take multiple loans to finance the same property.
Can I extend the tenure of my home loan?
Ans: Yes, you can. But the highest you can extend is up to 30 years. Another important thing is that the banks will allow you to pay interest till you are 60 years old. So, if you are 45 years old, the longest tenure you will get is 15 years.
What does an EMI mean?
Ans: EMI stands for Equated Monthly Installment. It includes both the repayment of the principal amount and the payment of the interest amount in a predefined ratio.
How much can I downpayment while taking a home loan?
Ans: The amount may vary depending on the total cost of the property, income, and savings. Usually, a 20% down payment is widely considered to be the ideal down payment amount for most home loan services.