Step-up loans: An easy way to own a dream house

Here's an innovative home loan product that is gaining popularity amongst borrowers.

The Indian retail loan market has undergone many changes over the years. Increased competition in the lending segment has led banks and financial institutions to battle it out by coming up with innovative schemes to attract potential borrowers. Step-up loans or step-up repayment facility (SURF) is one such innovation for home loan products which are gaining popularity amongst borrowers.

A step-up loan is one in which a bank or a financial institution lends money taking into account the borrower's future income. The lender decides the loan amount for which an individual is eligible on the basis of the borrower's expected professional growth. In this way, a borrower qualifies for a larger loan amount even if her/his present salary is low.

Usually, step-up loans can increase the loan amount by 5 per cent to 30 per cent depending upon the employment status of the borrower, i.e. whether the borrower is a government employee, a CA or a management graduate.

In case of a government employee, the loan amount may be lower than say a management graduate as the future jump in salary is expected to be lower than that of a management professional working in financial sector. As a rule, lending institutions decide on the loan amount and equal monthly installments (EMI) for step-up loans, on a case by case basis as they need to be convinced about the borrower's professional growth.

Apart from this, factors like an individual's background, her/his educational qualifications and the likes are used to arrive at the borrower's future salary package.

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Features

Flexibility in loan repayment

These loans are structured in such a way that the EMIs increase as the loan progresses. It means that, during the initial years the EMI amounts are low and they go on increasing over the tenure of the loan.

Initially, a considerable part of EMIs is used to pay off just the interest, but as the loan progresses, the principal amount also starts getting covered in the EMI amounts.

Expensive alternative

As compared to other home loan schemes, step-up loans are considered to be expensive because the repayment of the principal amount starts after a certain time period (or a phase). As during the initial years (or the first phase), the borrower repays just the interest, he ends up paying interest for the entire principal amount.

Tax deductions

Interest on home loans is deductible under Section 24 of the Income Tax Act up to Rs 1,50,000. As the initial years are spent only in servicing the loan, the borrower can maximise tax benefits on this front and reduce the total cost of his borrowing.

Who does it cater to?

For the lenders, these loans are high risk and thus they are offered on a very selective basis. There are chances that the expected increment in salary may not happen, or the borrower may simply get laid off. These factors could make the loan a bad debt for the bank and a cause of agony for the borrower. So, these home loans schemes have strict eligibility criteria.

These loans are ideal for young professionals and double income households in initial stages of their careers and who expect a considerable hike in income during the course of their employment.

Risks to the borrower

Before availing this scheme a borrower should try to understand the risks associated with the step-up facility.

Interest rate risk is quite high in these loans because during the early years, repayment of the principal amount is very low. So, paying the EMI could be a burden in the later years, especially if the interest is to be charged at floating rate in times of rising interest rates.

When availing a step-up loan, borrowers should opt for fixed rate option rather than floating rate to have a better control over EMIs.

It is advised that an individual should be sensible in assessing the amount of future increment while trying to avail this loan. Over borrowing may invite financial turmoil in the future. So, one should limit the amount borrowed on this type of loan.

Who gives these loans?

In private sector, banks like ICICI Bank and HDFC Bank offer step-up home loans to eligible customers. Similarly, Saraswat Bank's 'Vaastu Siddhi Home Loan' provides the SURF to customers.

Not many public sector banks provide pure step-up loans, i.e. they may not increase the loan amount in any case though they allow step-up repayment facility on home loans. Union Bank of India and Corporation Bank are two public sector banks providing step-up loans to home loan borrowers.