When it comes to financing a new home, people have a lot of questions for which they need to find answers even before they begin the property search. For example, how big a house can one afford to buy? What will be interest that will be charged for a housing loan? What should be tenor of the loan? What will be the impact of past credit defaults on future borrowing ability?
Buying a home is by far one of the most crucial decisions in a person’s life. Crucial because it is not something as simple as getting up one fine day and deciding to buy it. Other than millionaires who may be having unlimited funds at their disposal, for most of us belonging to the working class, this decision requires a lot of planning in advance. A major part of the planning would focus on generating finances both from external sources like banks/financial institutions and internal sources like borrowing from family & friends.
Banks while sanctioning home loans evaluate the borrower’s finance and also the property documents which may take up a lot of time. Is there an option of splitting up the approval process in such a way that makes it faster and easier for buyers? The answer to this question is a ‘Yes’ and it can be achieved by getting a loan pre-approved before you begin your search for a house.
What exactly is a pre-approved home loan?
This is a facility offered by banks and financial institutions whereby potential buyers interested in buying a house can make an application for pre-approval of a loan even before they zero in on any property.
Banks check the applicant’s credit history, verify the income, and provide a certificate stating that the borrower would in principle be able to avail of a loan up to a certain amount subject to meeting certain terms and conditions.
State Bank of India (SBI), for example, has pre-approved home loans facility (SBI PAL) which is offered to both its existing customers as well as new to bank customers. After verifying the financials, the bank evaluates the pre-approval application and sanctions a loan which is valid for a period of 4 months. The home buyer can avail of the loan during this period, after submitting the relevant property documents for due diligence check and verification by the bank.
How are loans pre-approved?
Often banks offer their existing customers pre-approved loan facility as part of a promotional event. Typically these are offered to customers who may have earlier availed a loan from the bank and maintained a clean credit record.
In addition to promotional offers, banks nowadays offer this facility to anyone intending to buy a home irrespective of whether they are customers of the bank or not.
The procedure for availing such loan is as follows:
- The borrower makes an application to the bank for a pre-approved home loan. Banks like ICICI provide borrowers the option of making this application online too. Documentation pertaining to borrower’s income and identity as stipulated by the bank will have to be submitted at this stage. The applicant may have to furnish information pertaining to his current residence, employment status and salary, marital status etc.
- Banks would ascertain the borrowers repayment capacity based on income proof submitted and decide how much they can lend. Since home loans are secured loans, banks will also check the borrower’s credit score with Credit Information Bureau (India)-CIBIL.
- Once the necessary verifications are done and approved the bank would issue a loan sanction letter. This sanction letter would normally be valid for a specific period of time which will be clearly stated therein. The letter will also state all the other terms and conditions of the pre-approval subject to which the final disbursal will happen.
- The interest rate applicable for the home loan would be mentioned in the sanction letter which would be based on home loan rates prevailing at that point of time. This interest rate too, will be valid only for a specific period from the date of issue of the sanction letter. Thereafter the rate would change depending upon the type of rate chosen by the borrower (i.e., fixed or floating) and the interest rates prevailing at the time of actual disbursal.
- Loan processing fee will be charged by banks for pre-approving a loan. This fee may vary from bank to bank. For example, State Bank of India charges full processing fees at the pre-approval stage itself which is not refundable. This essentially means that this amount would be forfeited in case the borrower fails to take up the offer within the offer validity period of 4 months or 120 days for which the sanction letter is issued.
- To avail of the loan, the borrower should identify a property before the expiry date on the sanction letter. The property documents should be submitted to the bank and if the documents are found to be in order, the loan will be disbursed.
How can you benefit from pre-approved loans?
Plan your finances. Imagine a situation where you decide on a property and its price, only to realize later that you would be able to borrow much less than what you thought you were eligible for. Needless to say your finances would go for a toss and you may have to reconsider your buying decision altogether.
The biggest advantage of a pre-approved home loan is that it gives the borrower a clear idea of how much he can borrow from a bank. This enables the borrower to plan and arrange for funds from other sources like drawing from savings, borrowing from family/friends, selling shares or withdrawing bank deposits.
Faster processing. Based on financial statements and credit record of the borrower, banks offer pre-approved loans. Unlike standard home loans, banks do not evaluate both financial documents as well as property papers at the time of pre-approval. Only financial documents are evaluated at this stage which makes the processing much faster. Prior to disbursal, provided there have been no significant changes in the borrower’s income, only property documents will be verified by the lending bank. Thus the processing time involved at the time of disbursal too would reduce.
Focused property search. When you have a clear picture of your finances — both how much you can borrow from banks and generate from your own sources — you will know exactly what your budget for buying the house should be. You need not spend time in looking at property which may be good but completely out of your reach.
Edge over other buyers. When you have a loan sanctioned, builders/property sellers will take you seriously. You can negotiate better and make faster payment as compared to other buyers.
Discounted rates on pre-approved loan. Many a time, banks offer a discount on the rate of interest applicable for pre-approved loans. Although not significant, these discounts are genuine. Considering that ticket size of most home loans is usually large, even a small discount can save the interest cost considerably.
Cons of pre-approved loans
Disbursal not guaranteed. Pre-approval is just a formal offer of a loan made by a bank. Being pre-approved does not mean guaranteed disbursal of the loan. The actual disbursal would be subject to the borrower identifying the property within the validity period of the pre-approved loan and the property meeting the bank’s due diligence requirements.
Validity period. The period within which a borrower is required to avail of a pre-approved loan varies from bank to bank. It can range anywhere between 2 to 6 months. This often compels buyers to take decisions fast even though it may not be the best one.
Changes in interest rate. Banks take into consideration the interest rate prevailing at the time of application to calculate the borrower’s repayment capacity. Any change of interest rate thereafter during the tenor of pre-approval will impact the final loan amount. Thus the amount disbursed may actually be different from the sanctioned loan amount because of adverse impact of interest rate changes.
Should you go for it?
Arranging finances for buying a house can be challenging to say the least. Pre-approved loans can be really handy under such circumstances to ensure that your calculations do not go wrong. It basically introduces an element of certainty which a home buyer can rely upon.
However, validity period of the pre-approved loan is something which can impact the borrower in more ways than one. It may compel people to buy property even though it may not be their ideal choice. Often selecting a home may take much longer than 120-180 days. This would mean forfeiting the processing fee paid and repeating the whole process once again to avail of a loan subsequently.
To conclude, taking into consideration the pros and cons of this facility, home buyers should do a few things before applying for a pre-approved loan. The borrower should try to identify a few properties (3-4) that he may be interested in buying. Once the search is narrowed down, the borrower must do some calculations to figure out how much funds he can generate from personal sources. Finally to meet any shortfall, he should apply for a pre-approved loan. Once the loan is pre-approved he will be in a position to easily take a decision and finalize the property well within his budget and during the tenor of the pre-approved loan.