You are an analyst in a Bank/NBFC and need to evaluate on a proposal where the customer is looking for Loan against his/her Property (LAP). How do you go about doing that?

The following are the set of aspects that need to be considered and looked into from the perspective of an Analyst

• Higher the monthly disposable income, higher will be the amount customer will be eligible for loan

• Typically a bank assumes that about 50-60% of monthly disposable/surplus income is available for repayment of loan

• The amount of loan depends on applicant’s age , tenure of loan and interest rate

Banks generally offer either of the following loan options:

  • Floating Rate Home Loans
  • Fixed Rate Home Loans

In a pure fixed loan, the EMI due to the bank remains constant

The floating interest rate is made up of two parts

  • Index
  • Spread

The index is a measure of interest rates generally and the spread is an extra amount that the banker adds to cover credit risk , profit mark up etc.

The index for Banks is MCLR (Marginal Cost of Fund Based Lending Rate). It is the internal benchmark rate for banks used for benchmarking floating rate loans effective from 1st April 2016.

MCLR is based on marginal cost of funds, negative carry on account of CRR, Operating Cost and Tenor Premium.

How is Marginal Cost of funds calculated by Banks:

  • Marginal Cost of Funds = (92%*Marginal Cost of Borrowings)+(8%*Return on NetWorth)
  • Here, the weight given to return on networth is set equivalent to the 8% of risk weighted assets prescribed as Tier I capital for the bank.
  • The marginal cost of borrowing refers to the average rates at which deposits of a similar maturity were raised in the specified period preceding the date of review, weighed by their outstanding balance in the bank’s books.
  • Rates offered on deposits of a similar maturity on the date of review/ rates at which funds raised x Balance outstanding as a percentage of total funds (other than equity) as on any day, but not more than seven calendar days prior to the date from which the MCLR becomes effective.

Negative carry on account of Cash reserve ratio (CRR) : Negative carry on the mandatory CRR arises because the return on CRR balances is nil. Negative carry on mandatory Statutory Liquidity Ratio (SLR) balances may arise if the actual return thereon is less than the cost of funds.

Operating Cost is associated with providing the loan product, including cost of raising funds, but excluding those costs which are separately recovered by way of service charges.

Tenor Premium : The change in tenor premium cannot be borrower specific or loan class specific. In other words, the tenor premium will be uniform for all types of loans for a given residual tenor.

Banks may publish every month the internal benchmark/ MCLR for the following maturities:

            • Overnight MCLR,
            • One-month MCLR,
            • Three-month MCLR,
            • Six month MCLR,
            • One year MCLR.
            • MCLR for any other maturity which the bank considers fit

Interest rate on each floating rate loan would be reset on based on the duration of the MCLR to which it is linked

The EMI of a floating rate loan changes with changes in market interest rates. If market rates increase, repayment increases. When rate falls, dues also fall.

Security

  • Security for a loan is typically a first mortgage of the property normally by way of deposit of title deeds.
  • Banks also ask for other collateral security as may be necessary.
  • Collateral security assigned to banks could be
    • Life Insurance Policies, the surrender value of which is set at a certain percentage to the loan amount
    • Guarantees from Solvent guarantors
    • Pledge of shares/securities and investments like KVP/NSC etc. that are acceptable to the banker
    • Banks would also require the borrower to ensure that the title to the property is free from any encumbrance (i.e, there should not be any existing mortgage, loan or litigation which is likely to affect the title to the property adversely)

Fees

  • Loan origination or processing charges
  • Administrative charges
  • Documentation
  • Late payment
  • Changing the loan tenure
  • Switching to different loan package during the loan tenure
  • Restructuring of Loan
  • Changing from fixed to floating interest rate loan and vice versa
  • Legal fee
  • Technical inspection fee
  • Recurring annual service fee
  • Document retrieval charges and pre-payment charges

Financial Appraisal

  • Past repayment records including defaulting, late payments, delinquencies and bankruptcies, earnings potential (including potential), any outstanding debt, assets, liabilities
  • Stability of income
  • Age

Technical Appraisal

  • Validity of approvals for construction from local government bodies
  • Compliance with building laws

Legal Appraisal

  • Sale Deed (Agreement for Sale)
  • Development Agreement
  • Encumbrance Certificate
  • Property related papers
  • Validation of succession of title
  • Credit Bureau Report

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