Many times people looking to buy a home find their eligibility amount just a shade lower than what is required to get them their dream home. In order to help out such people in realizing their dreams the HFCs have come up with an innovative idea of fixing eligibility amount higher than as per conventional calculations. This is what is called a Step up loan where the applicant is approved an amount that is higher than permitted by his current income.
Understanding the Concept
In this model of home loans the applicant is considered for a higher amount of loan by taking into account the prospect of professional growth that shall ensure higher earnings in the future. In this process the applicant is leveraging his future increase in pay for availing a loan higher than the conventional process. The average increase in the loan amount could range from 5% to 30 % depending on various factors such as type of job, sector of employment and qualifications of the individual.
Such a loan that caters for increase in earnings at later stage of life is most suited for double income couples and young professional at the beginning of their earning careers. Government employees with assured pay hikes and IT professionals who generally get significant hikes are also likely to benefit from such schemes.
Key features of Step Up Loans
Installment Structure: In this case the EMIs are not constant. The installments are lower in the initial years when it is assumed that the earnings of the borrower is less. As the loan progresses the installment amount increases and is maximum towards the end. This enhancement in EMI amount can be yearly or in steps of 3 or 5 years.
Total Cost: The overall cost of the step up loan by the time it is completely repaid is substantially higher than a conventional home loan. This is because fo the fact that in the initial years the major portion is used against the interest element with the principal still remaining largely outstanding to be catered for in the later years. If the rate of interest is floating in a step up loan then any increase in interest rates later on will imply significant increase in the total amount repaid towards the loan.
Tax Benefits: The step up loan gives additional tax benefits to the borrower under section 24 as with the same smaller income he now can utilize the entire Rs. 150000 exemption since the EMIs will be high enough with greater percentage of interest element in the initial years.
Inherent Risks of Step Up Loans
Interest Rates: Since the initial years payment is mostly towards interest while the principal hardly reduces any increase in interest rates will have a snow ball effect on the payments. Thus it is prudent to opt for fixed interest rates in such loans.
Lower Income: In case the borrower is not able to increase earnings as predicted while taking the loan there will be considerable financial difficulties in continuing the repayments at the later stages.
Despite the scope of getting a higher amount the step up loans must be availed with caution after due considerations of all aspects.