Simple Things You Can Do to Save and Arrange for a Home Loan Down Payment

One of my friends had made up her mind to buy a house. She went about the whole thing in a systematic way. Since she was working with an MNC and earning well, getting a pre-approved home loan sanctioned from her bank was fairly simple. After the pre-approval she identified a house, the purchase price of which was almost the same as her sanctioned loan amount. Finally when she approached the bank for disbursal of the loan, she was in for a surprise. The bank informed her that the entire purchase price of her house would not be funded by the bank.

Subject to her meeting certain terms and conditions, the bank would fund her only 80% of the purchase price, she was told. In other words, the purchaser (in this case, my friend) would have to shell out the remaining 20% from her own pocket. My friend was in a spot — she had to finalize the deal by paying the “down payment” amount to the builder within a month. Since most of her financial assets were locked in funds which could not be liquidated easily it was going to be a challenge for her to generate the funds.

There are many people like my friend who may have invested in assets with lock-in period. There may be others who may not have accumulated enough savings to make the down payment.

What exactly is down payment amount? What is the rationale for it? What are some of the sources from which a homebuyer can raise this amount? The purpose of this article is to provide answers to some of these questions pertaining to “Down Payment”.

What is down payment?

In India, Banks are authorized by the Reserve Bank of India to lend only up to 80% of the purchase price of a property. The balance of 20%,  referred to as “down payment” has to be arranged by the borrower. To quote an example, in case the purchase price of a house is Rs 25 lakhs, banks would lend only Rs 20 lakhs. The remaining amount of Rs 5 lakhs towards down payment of the house will have to be arranged by the borrower.

Down payment is basically margin money for a loan which has to be paid up-front by the homebuyer. The requirement has been stipulated by RBI with a view to regulate real estate lending and impose a check on banks financing for homes without any limit.

For the lender, this payment provides some sort of cushioning or reassurance about the borrower’s financial commitment and strength. For example, should the loan go bad at a later date for any reason whatsoever, the lender will be able to recover the full amount of loan by disposing off the property. Also, when a borrower invests his own personal funds, he is likely to be more committed to meet his loan obligations than otherwise.

Accumulating funds to make down payment

For an average home buyer belonging to the working class, arranging for the down payment amount may not be easy. To begin with it would take at least a few years to set aside and accumulate enough funds for this purpose.

According to a research property prices in cities like Mumbai are very high and have gone up by almost 50 per cent over the last 3-4 years. Effectively this means that a for mid-income professional earning a salary of around Rs 8 lakhs per annum  it will take around 13 years to accumulate enough money for making the down payment! (Calculations based on the assumption that the individual will be getting a salary raise of 10% annually and be saving one fourth of his income). Hence the study recommends that unless a person earns at least Rs 25 lakhs per annum he should not consider buying a property in the city.

Saving for a down payment

Planning for buying a home must start much before you actually decide to buy it. In fact once you are financially independent, you should start investing in some form of SIP toward achieving your goal of buying a home for yourself.

The number of years for which you may have to save will depend upon your salary, the amount of money you can put away each month and the price of the property you wish to buy. For example your goal is to collect Rs 10 lakhs, by saving Rs 5000 every month you will be able to achieve your goal at the end of 12 years and 2 months. Here we have assumed that savings earn interest @ 5%.

Instead of normal savings account (earning 5%), there are other options which fetch better returns. Investing in debt linked savings or debt linked mutual funds are some of the options that you can consider. Here it is important to bear in mind that whichever investment option you choose, it should be totally secure and liquid to a very large extent. While deciding on the duration of investment (e.g. time period for a recurring deposit) it may be worthwhile to take into account the time frame that you may have set for yourself for buying a home.

How to arrange for the down payment?

An ideal situation would be one in which you decide to buy a house after saving enough to fund the down payment entirely on your own. However in reality this may not always be possible. Under such circumstances what are some of the sources from which you can raise the down payment?

  • Loan from employer: Many employers offer general purpose loans to their employees at low interest rates. The process of availing this loan and documentation required is usually simple.
  • Finance against securities: To make a down payment, you can raise funds by pledging financial assets like shares, securities, insurance policies etc. Loans are offered by most banks against demat shares, RBI Relief Bonds, mutual fund units, insurance policies, UTI bonds, NSC and KVP. Loans against securities provide you instant liquidity without having to sell your securities.
  • Loan from Employees provident fund: In case you have had an Employee provident fund account for more than 5 years you can consider taking a loan from that account to make the down payment.
  • Home Loan Down Payment loans:  Although not offered by most commercial banks, finance companies like Muthoot Finance offer loans to finance home loan margin money requirements. Referred to as HDP loan (‘Home Down Payment Loan), this loan scheme was launched in 2014.  Anyone can borrow under this scheme for making down payment of a new property, extension/modification of an existing property and for renovation/refurbishment. Under the scheme borrowers can avail of a loan upto Rs 1 Crore at an interest rate of 11 per cent (subject to change) for a period of 12 to 60 months. The loan is secured against gold and hence the borrower is not required to submit any property papers. No additional expenses in the form of processing fee are involved. Borrowers also have the flexibility to prepay the loan without any penalty being levied. It is important to understand that any type of loan that you avail for generating the down payment will eventually impact your disposable income and hence your home loan eligibility amount too.
  • Borrow from friends or relatives: If you have parents or relatives who have spare funds, borrowing from them could be an option you can consider. Although interest free, you would still have to plan and repay the sum at some point of time in future.

Bottom line

Today most people belonging to the working class in India consider buying a home as one of their top priorities. In a developing economy like ours, with salaries rising and financial institutions wooing home buyers with attractive loan packages, it is no surprise that the demand for housing is on the rise. However it would be foolish to buy a house simply because you can avail a loan for purchasing it. A lot of planning should be done before you actually take the plunge. As part of the planning process, you must do a detailed analysis of your financial position with a view to:

  1. Check out how much of your own money you have and how much you will have to borrow by way of a home loan
  2. Set aside a small portion of your own money for emergency purposes
  3. Calculate whether your own resources will be adequate to cover the down payment and other incidental costs (stamp duty, registration, parking space cost and insurance etc.)
  4. Compare the total amount of your financial resources with the average cost of flat/apartment/ house that you intend to buy in city of your choice
  5. Ascertain whether you can actually afford the purchase and be in a position to fund the loan EMI going forward

A little bit of planning can go a long way in ensuring that complicated buying decisions like buying house is executed smoothly. All that is required on the home buyer’s part is to spend some time and effort in doing the above analysis thoroughly. Once this is done properly, the buyer can stay assured that the final decision is a correct one which can’t go wrong drastically.

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