Investment in a property can be highly profitable. But when you need cash to meet your unexpected expenditure (like medical expenses or child education expenses) it may not be possible to sell it. Infact no one would like to sell their property to meet short term unexpected expenses.
Real life experience:
One of my friend is employed in an IT company, resides in his own house in Bangalore. The value of his ancestral property is around Rs 1.75 Crore. His parents are financially dependent on him and staying along with him. Five months back, his mother had undergone a major heart surgery. The total cost of the surgery was Rs 6 Lakhs. There was no medical insurance for his parents. He did not have sufficient emergency fund also. So, he had taken a personal loan of Rs 5 Lakhs to fund the medical expenses.
His situation is like being ASSET RICH but CASH POOR.
Were there any options available to him so that he could have unlocked the value of his self-occupied property? Are personal loans costly compared to these available options? Whether he still has better options? Let us understand about these options and find out how much money he can save in terms of interest payment.
What are Personal Loans?:
A personal loan is an unsecured (no collateral required) loan. It is a loan for a fixed amount to be paid back in equal installments over a fixed time frame.
- High interest rates are charged on personal loans
- Offered for shorter tenure. Maximum tenure offered can be 5 years
- No Tax benefits are applicable on these loans
- A self-employed individual may find it difficult to get a personal loan
Different ways of unlocking the value of your Property to generate cash:
Now, let us understand about the ways in which you can unlock the value of your house to generate cash when needed.
1) Loan Against Property : This can be taken for following purposes
•Expanding your business
• Get your child married
• Send your child for higher studies
• Fund your dream vacation
• Fund Medical Treatments
Generally 50 to 60% of the current value of the property can be issued as a loan. Most of the financial institutions provide these loans for the tenure of upto 15 years.
2) Top-up home loan: These are offered to existing home loan borrowers of a bank.This loan can be used for any personal requirement (other than for speculative purposes). The tenure of the loans can be upto 20 years. The maximum loan amount can be upto 70% of the property value, minus the outstanding home loan. Interestingly, tax benefits (Section 24) can be availed on these loans.
3) Home Imporvement Loan: These loans can be taken for internal and external repairs of a house. This can also be used to extend the existing house. Up to 80% for extension and 100% of the cost of renovation can be sanctioned as a loan. The loan tenure can be upto 15 years.
4) Loan Against rent receivables: The loan amount can be used for any purpose. Loan is sanctioned based on the rent receivables of a property. Upto 75% of the net rent receivable over the lease period can be availed as a loan. The loan tenure generally depends on the lease period of the property.
5) Property Overdraft account: The loan amount can be used for any purpose. Upto 65% of the value of the property is given as a loan. But the loan tenure can not be more than 5 years.
6) Reverse Mortgage: These loans can be a boon for senior citizens (above 60 years age). In a typical mortgage, you borrow money in lump sum right at the beginning and then pay it back over a period of time using Equated Monthly Installments (EMIs).
In reverse mortgage, you pledge a property you already own (with no existing loan outstanding against it). The bank, in turn, gives you a series of cash-flows for a fixed tenure. These can be thought of as reverse EMIs. Upto 70% of the current value of the property can be taken as a loan.
Average interest rates on these loans:
The general terms and conditions on these loans are based on certain criteria like :
- What is the quantum of loan required
- Type of property – Residential or Commercial
- Usage of the property – Self occupied or let out or vacant
- Occupation of the applicant – Salaried or Self-employed
With reference to my friend’s case , how much money my friend can save if he opts for a Loan Against Property instead of the personal loan? Let us find out this by using the “Total Interest payable calculator“. You may alter the variables and analyze the results.
I have advised my friend to opt for a Loan Against Property and use the proceeds to prepay the personal loan account. (Always, check if there is any prepayment penalty applicable)
It is advisable to stay away from any kind of high cost loans. Best suggestion is to maintain an Emergency fund ( i.e., 3 to 6 times of your monthly expenses) as cash or near cash investments ( investments that can be converted into cash in less than 48 hours). You can use this emergency fund to tide over any unexpected expenditure.
Do you maintain emergency fund? Where do you invest it? Please share your views and comments.
(You may like visiting my post on “Best health insurance options for parents”)