Mortgage guarantee makes home loans accessible but it comes at a cost

Evaluate your ability to repay before opting for it

Last week LIC Housing Finance (LICHF) tied up with India Mortgage Guarantee Corporation (IMGC) to offer longer-tenure loans. LICHF will now offer loans to older customers till the age of 75. With an enhanced tenure, borrowers will be able to take a higher loan amount, or may opt for a lower equated monthly instalment (EMI). All this becomes possible when a lender ties up with a mortgage guarantor. 

What is mortgage guarantee?

Mortgage guarantee is a risk transfer tool. The risk of the home loan gets transferred from the bank/housing finance company to the mortgage guarantee company. “The house is the underlying security in a home loan. If the lender is unable to recover the due amount by selling the house, it is made good by IMGC,” says Sovan Mandal, chief commercial officer, India Mortgage Guarantee Corporation.

         

Improved eligibility, higher loan amount: The foremost advantage of mortgage guarantee is that it improves customers’ eligibility. Suppose that a borrower with a relatively poor credit profile approaches a top-notch lender. Normally, the latter would not approve of the loan. But with mortgage guarantee support it becomes willing to lend to this customer. “Such a borrower will not have to go to, say, a non-banking finance company (NBFC), which would charge him a higher rate of interest,” says Mandal. 

With mortgage guarantee, lenders become prepared to enhance the loan amount by 20-30 per cent. Younger buyers often postpone the purchase of a house because they lack the money for down payment. But in a mortgage guarantee product, they are able to get a higher loan to value (LTV) ratio, subject to RBI limits. They do not have to rely on more expensive loans such as personal, gold loan, etc.

When people buy a home, finances get stretched for the first few years until income rises. But if the lender is willing to offer a higher tenure, the EMI comes down, which makes things easier for the borrower (see table).

Mortgage guarantee can also improve older peoples’ access to credit. Most lenders prefer the loan tenure to end at 60. Home loans are available for as long as 30 years. One would have to buy a house at 30 to get a 30-year loan. But most people buy a house at a later age, and hence are eligible for a shorter-tenure loan. With mortgage guarantee, lenders become willing to lend till beyond the retirement age. A 45-year old can, for instance, avail of at best a 15-year loan. This short tenure affects the loan amount he is eligible for. His EMI also becomes intolerably high. LICHFL, for instance, earlier gave 20-year loans to people with pension income till the age of 70. With mortgage guarantee, it will now offer 30-year loans until the age of 75.

With mortgage guarantee support, lenders also become willing to lend to salaried people working in the SME sector, or with small-time employers. Normally, they prefer to lend only to people working for large, reputed organisations. IMGC has so far tied up with lenders like State Bank of India, Axis, ICICI, Bank of Baroda, Tata Capital, LIC Housing Finance, and so on.

Risk of moral hazard: While improved access to credit is a positive development, one fear is that it could give rise to moral hazard. One of the key causes of the 2008 financial crisis was lax underwriting standards. Easy credit can lead to an asset bubble. It can also lead to higher defaults later, which could in turn raise interest rates within the sector as a whole. “The regulator will have to strictly monitor this product and ensure that it does not create systemic risk,” says Arun Ramamurthy, founder and director, Credit Sudhaar. 

Bear in mind the cost: Customers should bear in mind that mortgage guarantee comes at a cost. Some lenders are currently charging a one-time fee of about 1-1.5 per cent of the loan amount. In future, some may pass it on in the form of a higher interest rate, where it is not visible. While it is okay to pay a fee for a facility, you must be aware of exactly how much you are paying.

There are other ways of avoiding the issue of limited eligibility for older borrowers. “If a borrower is 50 years old and the banks says that it will lend to him only up to 60, one option available to him is to take his son or younger brother as a co-borrower,” says Aditya Mishra, founder and chief executive officer, SwitchMe, a digital home loan broker. Only when this strategy fails should you pay the cost of mortgage guarantee.   

Check your repayment capacity: Banks and housing finance companies may today be willing to lend a higher amount, or beyond 60, based on mortgage guarantee. However, borrowers need to ask themselves whether they will be able to service the loan. “Ask yourself: Will you work after 60? Will you have the required cash flow to be able to service the EMI?” says Ramamurthy. Avoid over-leveraging. “The sum total of all your EMIs should not exceed 50 per cent of your net take-home salary,” adds Ramamurthy. Before going for a longer tenure, bear in mind that the overall interest cost you have to pay rises as the tenure increases. Finally, Mishra suggests that prepayment should be high on the priority of those availing of this facility.