Plan to buy a house? Here are essential terms to know before borrowing home loan

Buying a home is one of the crucial decisions of life, and it requires years of planning and investment. While many rely on investments to buy their dream home, others borrow money from lenders to fund the purchase of their new house. A home loan is a significant liability, and knowledge of key aspects of a loan can help borrowers to make an informed decision.

Home loan terms

As many people would plan to buy their dream house in next year, here are ten most essential terms home loan borrowers must know.

Principal Amount

Principal amount is the sum of money you will borrow from the lender for your home. The money doesn’t include interest charges. For example if you are planning to buy a property worth ₹30 lakh, and are ready to pay ₹10 lakh down payment. In that case you will borrow ₹20 lakh from the lender which will be the principal amount of your loan. 

Principal amount of your loan will determine the interest of your loan and its tenure. A higher principal amount borrowed for a longer time may lead to payment of higher EMI on your loan.

Interest Rate

The interest rate is the percentage charged by the lender on the principal amount. It can be of two types:

Fixed Rate: The rate remains constant throughout the loan tenure.

Floating Rate: The rate fluctuates based on market conditions and changes in the Reserve Bank of India (RBI) repo rates.

Why It’s Important: A lower interest rate can significantly reduce your monthly EMI and overall loan repayment.

Housing Loan EMI

EMI, or Equated Monthly Installment, is the fixed amount you pay to the lender every month to repay the loan. It includes both the principal and interest components.

How to Calculate It: Use a home loan calculator from a leading bank such as ICICI Bank to estimate your EMI based on the loan amount, interest rate, and tenure.

Why It’s Important: Knowing your EMI helps in budgeting and financial planning.

Loan Tenure

Loan tenure refers to the duration within which you agree to repay the housing loan. It typically ranges from 5 to 30 years.

Why It’s Important: A longer tenure results in lower EMIs but higher overall interest payments, conversely, a shorter tenure increases your EMIs but reduces the total interest outgo.

Processing Fee

The processing fee is a one-time charge levied by the lender to process your loan application. It’s usually a percentage of the loan amount or a fixed fee, ranging from 0.25% to 1%.

Why It’s Important: This fee adds to the initial cost of your housing loan, so factor it into your budget.

Loan-to-Value (LTV) Ratio

LTV ratio is the percentage of the property value that the lender agrees to finance through the loan. For instance, if the property costs Rs1 crore and the bank offers a loan of Rs80 lakhs, the LTV ratio is 80%.

Why It’s Important: A lower LTV ratio means you need to pay a higher down payment, while a higher LTV ratio reduces your upfront costs but increases your loan burden.

Prepayment and Foreclosure Charges

Prepayment: Paying a part of the principal amount before the due date.

Foreclosure: Repaying the entire outstanding loan amount before the loan tenure ends.

Some lenders may charge penalties for these actions, especially for loans with fixed interest rates.

Why It’s Important: Understanding these charges helps you plan for early repayments and save on interest costs.

Amortisation Schedule

An amortisation schedule is a detailed table showing the breakup of your EMIs into principal and interest components over the loan tenure. It also displays the outstanding loan balance after each payment.

Why It’s Important: This schedule helps you track your repayment progress and plan prepayments effectively.

Sanction Letter

The sanction letter is an official document provided by the lender after approving your loan application. It contains important details such as:

-Applicable interest rate.

Why It’s Important: It serves as a formal commitment from the lender and includes all critical loan terms.

Balance Transfer

A home loan balance transfer allows you to shift your existing loan to another lender offering better terms on home loan, such as lower interest rates or longer tenures.

Why It’s Important: It helps reduce your financial burden and save money on interest payments.

How to Use a Housing Loan EMI Calculator

A housing loan EMI calculator is an online tool that helps borrowers estimate their monthly EMIs. Here’s how it works:

-Enter Loan Amount: Input the principal amount you plan to borrow.2. Enter Interest Rate: Add the applicable interest rate offered by the lender.3. Enter Loan Tenure: Specify the loan duration in months or years.