Unit – 3
Housing Finance
Introduction
- Financial arrangements made by the housing finance companies to meet housing requirements is called housing finance.
- There were about 24 million houses short in 1997, most of which were in urban areas and among poor and low-income people.
- This background led to the formulation of National Housing and Habitat Policy (NHHP) in 1998. Stressing:
- Removal of barriers in housing finance.
- Treating housing finance in par with the priority sector.
- Creation of surplus in housing.
- Providing quality and cost-effective shelters to the vulnerable groups.
- Draft National Urban Housing and Habitat policy 2005 further recognized the need to enhance the flow of funds into the sector and highlighted the need of shelter in the years to come.
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Need for Housing Finance:
- Social stability
- Economic development
Role of Housing Finance
- Creation of equitable economic growth through the reduction of poverty and prevention of slum proliferation.
- Housing has highly significant social implications as it provides shelter for the family.
- Plays an intermediary role between the economy and the housing system.
- It drives the real estate business in India.
- It is an avenue to mobilize domestic savings in India.
- It develops innovative instruments to mobilize domestic savings.
- Plays an important role in creating employment, maintaining health, social stability, and decent human life.
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Types of Housing Finance
- Home purchase Loans: Basic home loans offered by banks and housing finance companies for purchasing a new house.
- Home construction loans
- Home extension loans
- Home conversion loans
- Land purchase loans: for both construction or investment purposes.
- Stamp duty loans:
- Bridge loans: offered for selling the existing house and purchasing another house.
- Balance transfer loans: where the balance outstanding is transferred to another loan either from the same bank or another bank to avail lower interest rates.
- Re-finance loans: banks can get housing loans re-financed from another financial institution.
- NRI home loans: meant for non-residents who wish to build a house in India.
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Institutions offering Housing Finance
- Housing and Urban Development Corporation of India (HUDCO)
- LIC Housing Finance Limited (LICHFL)
- GIC Housing Finance Limited (GICHFL)
- Dewan Housing Finance Corporation Limited (DHFCL)
- Can Fin Homes Limited (CFHL)
- Provident Funds
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Banks offering Housing Finance
- Scheduled Commercial banks
- Scheduled co-operative banks
- Regional Rural banks
- Agricultural and rural development banks
- Housing Development Finance Corporation Limited (HDFC)
- State Bank of India Home Finance (SBI)
- IDBI Home Finance Limited (IHFL)
- PNB Housing Finance Limited PNBHFL)
- National Housing Bank (NHB)
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Interest Rates
Depends on:
- Upon interest rate cycle
- Loan amount
- Tenure of loan
- Profile of the borrower
- Credit history
- Credit score (CRISIL, CIBIL, CARE etc.)
- Lending bank
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Types of interest rates:
Fixed interest rates - interest rate remains fixed throughout the tenure of the loan. E.g. HDFC
Floating interest rate - rate of interest changes depending upon changes in repo rates by RBI or any change in the base rate of the bank. Generally, floating rates are lower. E.g. SBI
Hybrid interest rate: Fixed in the initial years and floating for the remaining years.
- Prepayment of loan lender can not levy any penalty as per the guidelines of RBI.
- Borrower can shift from fixed to floating interest rate without any charge.
- Interest rates are expressed as certain points above the Base rate and certain points above or below PLR popularly known as Spread.
- Repayment by EMI, which includes both Principal and interest.
- EMI (Equated monthly installments)
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EMI = (p(1-dp)r) (1+r)n / (1+r)n -1
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Where, dp= percentage of down payment
p= principal amount
r= interest rate
n= time
Or
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EMI = (Loan amount * interest) (1+interest )n / (1+interest )n -1
For e.g. 1,00,000 loan repayment in 10 years having an interest rate of 8% compounded monthly. Down payment 10%. Calculate EMI.
Methods of calculating EMI
Flat rate system: interest is calculated on the initial loan amount for the entire loan period and principal and such interest is divided equally into repayment installments. Reduction in the Principal amount as each installment is paid is not taken into account. This makes effective interest quite expensive.
Reducing balance system: interest is charged only on the outstanding amount of the loan after deducting the principal repayment. Here the amount of interest is less.
E.g. A loan of Rs. 2,00,000 with a flat rate of interest of 10% p.a. for 5 years.
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Installment of Rs. 60,000 p.a (5,000 per month)
Total paid Rs. 3,00,000, leading to an interest rate of 17.27%.
Reducing Balance with the same example Total amount paid will be less instead of 3,00,000 in the flat rate system.
Types of reducing balance system
Daily reducing balance method: principal is reduced as and when the principal is repaid and the interest is calculated on the remaining balance.
Monthly reducing balance method: Principal is reduced when repayment is made at the end of the month and interest is calculated on the balance.
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Annual reducing balance method: At the end of the year the accumulated principal component is deducted from the original loan amount and the interest for the next year is calculated on the reduced loan amount.
Income Tax Implications
Deduction under Sec 80C – Deduction up to 1,50,000 for principal repayment
Section 24 – Deduction for interest payment
Section 80EE – additional deduction for interest.
Reverse Mortgage
- A Reverse Mortgage is a loan available to senior citizens.
- Reverse mortgage, as its name suggests, is exactly opposite of a typical mortgage, such as a home loan.
- It is a home loan product designed for the senior citizens converting their fixed assets-their home or in banking terms-equity in any housing property into an income channel for any requirement.
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How Reverse Mortgage works in India
- When the home is mortgaged to the bank, the bank arrives at the fair value of the property based on the condition of the property, demand for the property, location, current prices, etc.
- Once the fair value is determined, the bank disburses the loan amount in the form of periodic payments – monthly, quarterly, etc. The margin and interest costs are also factored in to arrive at the loan like any other loan.
Guidelines for Reverse Mortgage
- Loan Amount: Up to 60% of the property value
- Tenure: Generally 10-15 years (Some banks offer a longer tenure)
- Periodicity of Payments: Monthly, Quarterly, Annually, or Lump sum loan payment
- Property Revaluation: Undertaken once every 5 years.
- If valuation has increased, the borrowers can increase the loan amount. An incremental lump sum is paid.
- Equity: The equity or individuals' interest in the property decreases as they receive more payments. This is the exact opposite of a home loan where equity increases with each payment and more principal payments.
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Providers of Reverse Mortgage Loans in India
- State bank of India
- Bank of Baroda
- Dewan housing finance limited
- Punjab national bank
- Union Bank of India
- Interest rate: Interest rates on reverse mortgage loans in India range from 12-15%. State Bank of India has a loan scheme with a fixed interest rate of 12.75%.
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Features of Reverse Mortgage
- Dealing Parties
- Borrower
- Lender
- Security for the lender
- Payment of loan to the Borrower
- Repayment of Reverse Mortgage loan
- Home value Falling short
- Home value in Excess
- Freeing the property from reverse mortgage
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Eligibility Criteria
- Age: House owner's age should be above 60. If there is a co-applicant, she should be above 58 years.
- Ownership and Clear Title: The property title should be clear and be free from encumbrances. The prospective borrower should be the owner of the property.
- Life of the property: Should be minimum 20 years.
- Property should be self-acquired and occupied.
- Property should be the permanent and primary residence: The property can be either a residential house or a flat located anywhere in India. In addition to the above, each bank or lender could have additional criteria in accordance with their lending norms.
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Reverse Mortgage Advantages
- No prepayment penalty
- If one borrower dies, his or her spouse can continue to stay in the house.
- Regular Income
- No Repayment worries
- Utilizing Locked Savings
- Avoid Sale or renting
- Financially Independent
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Dis-advantages
- Pledge the property to the loan lender means officially giving the provider the right to sell the house to recover the loan. If the family of a house is willing to transfer the ownership to someone after the death then this loan is not to be considered as a source of income.
- High rate of interest compared to other loans.
- Variation in interest rates and loan amount during the property valuation can turn into serious problems at times.
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Criticisms of Reverse Mortgage
- It is expensive
- Customers are confused while entering into them
- Since no monthly payments are made by the borrower in a reverse mortgage, the interest that accrues is treated as a loan in advance.
- Each month, interest is calculated not only on the original amount received by the borrower but on the interest previously assessed to the loan.
- Recent reports seem to indicate that a very small percentage of senior citizens only seem to have taken advantage of this loan.
- The Indian Banking industry caps the available loan amount at 50 lakh instead of providing for an equitable percentage of the property's value and limits the loan period to a tenure of 15 years.
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Non-Banking Financial companies
- Began in 1960 to meet the existing need by the Investors.
- Started with accepting Fixed deposits from investors and work out leasing deals.
- 1980s and 1990s began to attract a large number of investors.
- Activities expanded to underwriting, stock broking, investment banking, asset management, portfolio management.
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“The financial institution which provides the various financial facilities but are not termed as banks because they do not possess the banking license" are called NBFCs.
- Registered under Companies Act 1956
- Governed by the directions issued by RBI
- NBFCs undertake services like equipment leasing, hire purchase, housing finance, investment, loan, stock-broking.
RBI (Amendment Act) 1997 defines NBFC as:
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- A financial institution which is a company.
- Principal business is receiving deposits or lending in any manner.
Company carrying on any of the following activities as its principal business is not NBFC:
- Agricultural operations
- Industrial activity
- Purchase or sale of any goods or providing services
- Purchase, construction, or sale of immovable property
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RBI - A company can be treated as NBFC:
- If its financial assets are more than 50% of its total assets.
- Income from financial assets is more than 50% of the gross income.
- A company cannot carry on business as an NBFC unless it is registered with RBI.
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Components of Non-banking sector
Non-banking financial companies
- Principal business is accepting deposits and lending in any manner.
- Insurance/Stock-broking/Housing Finance
- EL/HP/LC/IC/Mutual benefit finance company/ Miscellaneous non-banking company
Residuary non-banking company(RNBC)
- Receives deposits under any scheme by way of contributions, subscriptions, or by sale of units or certificates or other instruments.
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Non-banking non-financial company
- Is an industrial concern
- Principal activity is agricultural operation or
- Trading in goods and services or
- Construction or sale of real estates
- Not classified as financial or non-residuary non-banking company.
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Role of NBFCs
- Promotes utilization of savings
- Provides easy, timely, and unusual credit
- Financial super market
- Investing funds in productive purpose
- Provides housing finance
- Provides investment advice
- Increase the standard of living
- Accepts deposits in various forms
- Promotes economic growth
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Growth of NBFCs
- 1980-90s NBFCs grew fast owing to public money through deposits and IPOs.
- 1981 had 7063, 1990 had 24009, and 1995 saw 55995.
- 1991-97 saw deposits growth of 88.6% owing to high rates offered by NBFCs.
- Growth could not be sustained as loans extended turned sticky leading to several NBFCs to default on deposit repayments.
- 1997-98 saw RBI coming out with stringent regulations which made them difficult to raise deposits. Banks also turned wary of lending to NBFCs leading to increased cost of funds to NBFCs. Private banks also posed competition to NBFCs. Many exited business.
- 2001-02 saw recovery and strong growth.
- Competition picked up again leading to a decline of NBFCs to 12740 by June 2009. NBFCs started depending upon bank loans and debentures as against public deposits.
- There has been further reduction in the number of NBFCs and growth of asset management companies basically by way of re-classification of these companies.
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Functions of NBFCs
- Brokers of loanable funds
- Mobilisation of savings
- Channelisation of funds into investments
- Stabilise the capital market
- Provide liquidity
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Types of NBFCs
- Equipment Leasing Companies
- Hire purchase finance companies
- Housing finance company
- Investment company
- Loan company
- Miscellaneous non-banking company
- Mutual benefit finance companies
- Residuary non-banking company
- Non-banking non-financial company
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RBI guidelines for NBFCs
- Registration with RBI
- Inter-corporate deposits
- Maintenance of liquid assets
- Period of deposit for residuary NBFCs
- Accounting standards issued by the Institute of Chartered Accountants of India to be followed.
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Prudential norms for NBFCs
- Income recognition
- Income from investments
- Accounting standards
- Accounting for investments
- Provision requirements
- Disclosure in balance sheet
- Constitution of audit committee
- Capital adequacy requirements
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