Young and hungry for a home loan you can’t afford? There’s now a way to leverage your expected salary hikes in the future into a larger loan eligibility today. Enter a home loan innovation called step-up loan.
What’s a step-up loan?
It’s a home loan given on a case-to-case basis. It is given on the assumption that the borrower’s salary would get a hike year-on-year in the future. Noel Manoj, senior manager (sales and marketing), BankBazaar.com, an online loan comparator, says, “A step-up home loan offers the flexibility of an increased loan amount eligibility keeping in mind the future career growth and prospects of the home loan borrower.”
How much more?
Suppose, at your current monthly income of, say, Rs15,000, you can afford a loan of Rs8.33 lakh for 20 years. At 9% interest rate a year, your equated monthly instalment (EMI) would be Rs7,500. For the same income and term, you may get Rs10 lakh or more under a step-up loan, depending on your situation.
For example, a double-income house could get a higher step-up than a single-income one. Or somebody in a private sun-rise sector job could get a higher step-up than a government employee. Harsh Roongta, CEO, ApnaPaisa.com, says, “The loan eligibility could be 5-30% higher, depending on the individual.”
How does it work?
A step-up loan groups the loan term into two or three tranches. The tranche may vary between lenders. Roongta says: “The EMI you pay in the initial years is lower and increases as time goes by. In a typical 20-year step-up loan, the first three years see a lower EMI and the remaining 17 a higher one.”
While the amount would differ from bank to bank, there is a gradation of payment across time. “EMIs can be structured as you wish in accordance with your repayment capacity at any given point in time,” says Manoj of BankBazaar.com.
What it costs?
In the first few years, EMIs are largely made up of interest and the principal is nominal. The remaining years see much higher EMIs to recover the outstanding principal and interest. This makes these loans more expensive. “Step-up loans almost always have a higher total cost compared to a normal loan,” says Manoj. For example, a normal loan would see an EMI per lakh of Rs900 for a 20-year loan at 9% interest rate, but in a step-up loan, the first three years will have an EMI of Rs750, which will go up to Rs959 for the remaining 17 years. That’s an extra Rs6,000 per lakh over the loan tenure.
Who gives these loans?
At present, structured step-up loan products are available only with Union Bank of India (UBI) and ICICI Bank Ltd. However, most banks will give you this loan on a case-to-case basis. The UBI loan looks good since the rate of interest for both the step-up and the normal loan is the same. Most other banks tend to price the step-ups a bit higher. UBI’s head (retail), S.L. Bansal says: “It’s a flexible loan at the same interest rate. Whenever the customer expects a higher inflow of cash, he can pay an increased EMI. The excess amount goes to his principal amount.”
ICICI Bankoffers a step-up loan called Max Money. The bank did not give more details about their product.
Who gets these loans?
Banks do not give step-up loans easily because the risk is higher. Chances of an increment not coming as expected or a spouse stopping work due to family needs are risks to the loan repayment. Also, floating rate loans are risker since the borrower can be hit by an increased step-up EMI as well as rising interest rates, making it a bad loan for the bank and distress for the family.
That’s why such loans have stringent eligibility criteria and are restricted to salaried individuals with promising qualifications. So, exhale you management graduates, chartered accountants and engineers. But if you are a government employee, your future income will not see a multiplier jump and your eligibility is going to be lower than that of a management graduate employed with the financial sector in India. The self-employed have to be lucky to get a normal loan, forget about a step-up.
“The loan amount and EMI can be determined only on a case-to-case basis. The bank has to be convinced about the customer’s future career graph to avail the loan,” adds Bansal.
What to look out for
Undue optimism can put your family’s financial future at risk. Rising interest rates, economic meltdown and either a job loss or less-than-imagined increment are all recipes for disaster for a step-up loan borrower. Amar Pandit, a Mumbai-based certified financial planner, says: “One should never over-borrow on such a loan. If one has to go for such a loan, it is best to go in for a fixed rate option since with a floating rate option, the interest risk is too high.” He suggests a thumb rule for choosing a fixed rate option in the current interest rate regime—7-10%.
Should you take it?
Remember that a step-up loan looks at the problem from the eligibility side and not the cost side. Suresh Sadagopan, Ladder 7 financial adviser, says: “There is a need for products like these. Many professional couples who are at the beginning of their careers and want to go in for a house do not mind going for a slightly higher cost. They can use this product to their advantage.”
Our advice: Be prudent while imagining your future annual increments. It is safe to assume an inflation plus 1-2 percentage points as the average increment in the private sector. Use that as the base to forecast what you can pay in future. Remember that we are staring at high interest rates in the next couple of years. And, enjoy that mansion!