In my opinion, Pre-Approved Home Loan is one of the least risky way of buying a property through Home Loan by a buyer. Obviously it require intelligent planning and execution. Later in the post, I will explain how Pre-Approved Home Loan mitigate certain risks. Every product has its own advantages and disadvantages therefore before making any decision it is advisable to understand the product in detail. I receive lot of queries from my clients on Pre-Approved Home Loan therefore i decided to write a separate post on this subject. In my previous posts, i explained Pre-Approved Home Loan product in bits and pieces but this post is all about Pre-Approved Home Loans.
What is Pre-Approved Home Loan?
A Pre-Approved Home Loan is basically an intent or in-principal approval provided by Banks or Housing Finance companies to grant Home Loan to an individual on the basis of his Credit Profile / Credit Worthiness. In short, if potential borrower fulfill Home Loan eligibility conditions then an approval is provided for amount X which can be availed as Home Loan by the potential borrower within specific time frame normally upto 6 months. In my post, How Home Loan Eligibility is fixed? i explained all the factors which influence Home Loan Eligibility. All these factors hold true for Pre-Approved Home Loan. It is quite interesting to note that State Bank of India has separate Pre-Approved Home Loan Product known as SBI PAL. PAL is short form for Pre Approved Loan.
How to Apply?
You can apply for Pre-Approved Home Loan in a same manner as Normal Home Loan. Process is also same, only difference is that you need to select/mention in your Home Loan application that “Property is not identified“. List of Documents required vary depending on your profession e.g. self-employed, salaried or entrepreneur. Documents required for salaried individual are as follows
1. Proof of Identity
2. Proof of Address
3. Last 3 months salary slips
4. Latest Form 16
5. Last 3 years Income Tax Returns
6. Last 6 months Bank Statement
7. Last but not the least, Cheque for Processing Fee. Please note that Processing Fees is non-refundable.
Common Myths about Pre-Approved Home Loan
1. Pre-Approved Home is Guaranteed: Many of my clients are under impression that once bank has provided in-principal approval then Home Loan is guaranteed. Unfortunately it is not true, Why? lets understand with simple example.
When you invest in any financial product say NCD, Tax Free Bond, FMP or Company FD’s you basically check 2 parameters
(A) Repayment capability of issuer i.e. whether issuer can pay interest and repay principal or there is a possibility that issuer might go bust/insolvent. Basically investor check financial strength of an issuer / company / bank.
(B) What is the Risk associated with the product and whether issuer has all the approvals in place to offer the product or not
Similarly, Home Loan is like a financial investment tool for banks. Bank invest their money in Home Loan, Personal Loan, Car Loan etc and earn interest from Borrower which is income for bank. In this case, Product is Mortgage of Property and Issuer is Home Loan Borrower i.e. Home Loan Borrower is offering his property for Mortgage.
Pre-Approved Home Loan basically check only Point A i.e. Repayment Capability of a Borrower or credit worthiness of a borrower. In short, Bank decide how much amount they can invest (Approve as a Home Loan) depending on the financial strength of a borrower. In short, Banks only check credit worthiness of potential borrower.
Now when the property is finalized, banks check the product i.e. Risk associated with the product (Read: Property). If legal title is not clear or some govt approvals are not in place then bank may refuse to invest in such a product. In layman terms, Home Loan approval is 2 step process and Pre-Approved Home Loan is just 1st stepping stone. It only fixes the credit worthiness of the borrower. Risks assessment of property is done afterwards by the bank when the property is finalized.
2. Processing Fees is refundable if Home Loan is not availed: Another myth or wrong information from bank DSA’s that Processing fees is refundable. Processing fees is charged to process Home Loan application. It is more of administrative cost. Once the Pre-Approved Home Loan is sanctioned which implies Home Loan application is processed. Therefore there is no question of refund of processing fees in case of Pre-Approved Home Loan.
3. 100% of the sanctioned amount can be availed as Home Loan against Property Value: Another common myth. Please note that as per RBI guidelines banks can lend only 90% of property value as a Home Loan for Home Loans of upto 20 lakh i.e. LTV or Loan to Value Ratio is 90%. Similarly for Home Loan of between 20 lakh and 75 lakh, LTV is 80% & Loan to Value ratio is 75% for Home Loans of more than 75 lakh. As per RBI guidelines, stamp duty and registration charges are not included in the property value by the banks.
Advantages of Pre-Approved Home Loan
1. Better Financial Planning: This is one of the biggest advantage. Based on amount sanctioned in Pre-Approved Home Loan, a borrower can decide his property budget, self funding required & EMI outflow.
2. Avoid Future Shocks: When a buyer apply for Home Loan after property is finalized there is a risk of deal to fall through. For example, a buyer finalized a property of 1 Cr and he require home loan of 80 lakh but when he applied for Home Loan his eligibility is fixed at 50 lakhs only. Now only 2 options are left i.e. either to arrange balance 30 lakhs through self funding or let go the token amount paid and cancel the deal.
3. Better Negotiation Power: A buyer with Pre-Approved Home Loan stand better chance to get good deal from builder or seller. It shows that buyer is serious about the deal. Secondly, deal can be closed within 2-3 weeks time as bank has to only check property documents. Many sellers prefer buyers who can close the deal fast and would not mind offering some discount for this.
Disadvantages of Pre-Approved Home Loan
As one shoe doesn’t fit all therefore it is important to check other side of the story i.e. disadvantages of Pre-Approved Home Loan
1. Interest Rate: Interest Rate is locked at the time of pre-approval of Home Loan. It can be disadvantage if interest rates are falling. For example, if i apply for Pre-Approved Home Loan today and receive approval at 10.15% interest rate i.e. Base Rate of 10% + 0.15% mark up. In case interest rates are reduced after few months and instead of reducing base rate, bank decided to reduce mark up from 0.15% to 0% then as a borrower i will stand to Loose. My home loan will be disbursed at 10.15% ROI even if at the time of disbursement new customers are being offered ROI of 10% i.e. at Base Rate.
2. Processing Fees: As i mentioned earlier that processing fees is non-refundable therefore if you fail to finalize property normally within 6 months then approval will lapse. If you apply again then you need to pay processing fees again.
3. Lien on Credit Availability: Pre-Approved Home Loan put a lien equivalent to sanctioned amount on your total credit availability based on credit worthiness. In layman terms, if my credit worthiness is 50 lakh and bank Pre-Approved Home Loan of Rs 45 lakhs. If i apply for personal loan of 10 lakh within validity period of Pre-Approved Home Loan then my personal loan will be rejected. In short, a sort of lien is put on available credit limit equivalent to the sanctioned amount.
4. Multiple application shows Credit Hungry Behavior: If you keep applying for Pre-Approved Home Loan without closure of same then it will impact your credit score negatively. It shows credit hungry behavior therefore apply for Pre-Approved Home Loan only if you are seriously considering to buy a property and would like to close in next few months
5. Psychological pressure to close the deal: Last but not the least, i have observed that my clients who opted for Pre-Approved Home Loan had psychological pressure to close the deal under fear of losing out on processing fees. It may contradict the advantage of better negotiation power therefore it is advisable to apply only after careful consideration.
Summary: As i mentioned, every product has its own advantages and disadvantages. It is advisable to understand complete details before applying for Pre-Approved Home Loan. Some times you might see misleading advertisement through net banking interface of bank that bank has pre-approved home loan of 1 Cr for you. Please don’t fall prey to such misleading advertisements. These are just marketing gimmicks. Actual sanctioned amount might be 20 lakhs only.
Before applying for Home Loan, i suggest you do a basic ground work in terms of finalizing location, check current market rate, approximate Home Loan eligibility and more importantly whether the property fits your requirement or not. You will find some good calculators on internet which will estimate Home Loan eligibility depending on your income, age and current liabilities. Of-course they are not 100% accurate but will give rough idea. It is important that you should apply for Pre-Approved Home Loan only after you make up your mind to buy a property.
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