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Buying a home? 6 vital steps to follow

By Pankaj Anup Toppo, Outlook Money
July 08, 2009 13:25 IST
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When the real estate sector was on a dream run from 2002-03 till around January 2008, homebuyers in most cases overlooked many issues that are coming to the fore now. Avoiding some common mistakes can make the process of selecting and buying a house a little simpler.

Before you buy. Most mistakes happen at this stage.

Home search. A typical home search starts with scanning advertisements. But, this means you will have to check everything on your own - the developer's credentials, his ability to deliver on time and the approved building plan. Not easy to do. Developers aren't usually forthcoming with this information. Even if they are, analysing it is tough, especially if you are a first-time buyer.

If you find a house on your own and at a price that suits you, getting a loan from a bank or a housing finance company isn't easy. The institution will do its own due diligence before approving the loan, which means you will have to wait for some more time. And, if the lender finds a problem with the project, it may not sanction the loan.

A simpler way is to approach the bank or the HFC from where you plan to take the home loan. Most of them have a list of pre-approved properties. They include properties on which the necessary checks have been done. If you choose from this list, loan approval will be faster. The only hitch is that these properties will typically cost a little more.

Payment mode. There are usually two modes of payment - a lumpsum upfront payment and one that is construction-linked. In the lumpsum payment, you have to pay up to 95 per cent of the cost of the unit upfront. The developer gives a discount of 5-10 per cent on the cost of the property as he gets the funds upfront. Sounds great, but if the project gets stuck, you won't be able to do much about it.

With a construction-linked payment plan, if a project runs into rough weather, the hit you take will be lesser.

Developer agreement. The Agreement to Sell between a homebuyer and a developer is mostly heavily loaded against the former. What you can do is ensure that an exit clause and the approved building plan are made a part of the agreement.

Property dealers. Dealers can be pushy. Don't buckle under pressure. Cross-check what they say. Try to meet some people who have already bought into the project.

More importantly, arrive at a fair value of the property. There is always room for negotiations on the quoted price (see True Value Test). Get an idea of the paperwork from someone who has gone through the process.

Choosing the bank/HFC. More than looking at how conveniently the lender gives a loan, look at its response to interest rate movements. Look at how it revised its rates during the boom period. Choose an institution that is proactive in changing its home loan rates when interest rates move up or down.

From December 2009 you will have access to your credit score. Use a good credit score to get a better rate of interest on your loan.

After you buy. Visit the construction site to check the progress. If you spot any glitches, contact the developer. Get in touch with other people who have invested in the same project. Form a group and discuss the progress of the project. If there is a problem, take it up as a group.

For most of us, buying a house is once-in-a-lifetime decision. Do your bit to make this a happy experience.

True value test

Most people end up buying a property at a price that is more than its value. As a result, they have to either wait unduly long to get a good return or sell at a loss.
Follow these steps to correctly evaluate a rent-worthy property. Assume the asked price is Rs 35 lakh and the down payment is Rs 8.75 lakh (or 25 per cent of the property's value)

Step 1: Expected net operating income (NOI)
This is rental income minus operating expenses such as repairs. This cost excludes EMI

Rental Income - Operating Expenses = NOI
Rs 2.4 lakh-Rs 15,000= Rs 2.25 lakh

Step 2: Annual debt service amount
Lenders want the expected NOI to cover your annual debt obligation. So, they lend in a way that the repayment is covered by the NOI. If the bank wants a debt coverage ratio of 1.15 times, the annual debt service amount will be Rs 1,95,652.17

NOI / Debt Coverage Ratio = Annual Debt Service
Rs 2.25 lakh / 1.15 = Rs 1,95,652.17

Step 3: Debt service ratio
This is the annual debt obligation as a percentage of the total loan

(Annual Debt Obligation / Home Loan Amt)* 100 = Debt Service Ratio
(Rs 1,95,652.17 / Rs 26.25 lakh) * 100 = 7.45%

Step 4: Rate of return on your down payment
This depends on NOI yield and down payment portion

NOI Yield * Down Payment Contribution = Return on Down Payment
[(Rs 2.25 lakh / Rs 35 lakh) * 100 = 6.43%] *
[(Rs 8.75 lakh / Rs 35 lakh) * 100 = 25%]
6.43% * 25% = 1.61%

Step 5: Market capitalisation rate
This is the sum of the debt service ratio and the return on your down payment

Debt Service Ratio + Return on Down Payment = Market Capitalisation Rate
7.45% + 1.61% = 9.06%

Step 6: Property's right value
This is the true value of the property (V). This calculation shows the property is worth Rs 24.84 lakh, which is lower than the asked price of Rs 35 lakh.

NOI / Market Capitalisation Rate = V
Rs 2.25 lakh / 9.06% = Rs 24.83 lakh

Before you buy

  • Approach a bank or a housing finance company (HFC) from where you plan to take a loan and use their home search facility
  • A construction-linked payment plan minimises the loss if the project gets stuck
  • Make sure an exit clause and the approved building plan are made a part of the Agreement to Sell
  • Do your calculations (see True Value Test) and arrive at a fair value of the property
  • Find a lender that is proactive in revising its loan rates when interest rates move up or down
  • If you have a good credit score, use it to bargain for a better rate (personal credit scores will be available from December 2009)

After you buy

  • Regularly visit the construction site to check the progress
  • Get in touch with others invested in the project. Form a group. If there is a problem, take it up as a group

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Pankaj Anup Toppo, Outlook Money
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