How will the RBIs changes to home loan risk weights affect borrowers

In October 2020, the Reserve Bank of India (RBI) changed the rules for calculating the risk weights on home loans. This was done to make home loans easier and cheaper for borrowers while keeping the financial system stable. It's important to understand these changes if you're thinking about getting a home loan in India.

In this guide, we'll explain the RBI's new rules on home loan risk weights and how they affect borrowers. We'll cover everything you need to know in a simple and clear way. By the end, you'll understand how these changes impact your home loan and what you can do to handle them effectively.

What is the Risk Weight in Home Loans?

Risk weight in home loans is the percentage used by banks to decide how much money they need to set aside to cover potential losses from those loans. It helps banks measure the risk of lending and ensures they have enough funds to handle possible defaults.

Let's say you take a home loan of ₹50 lakhs from a bank. If the RBI assigns a risk weight of 50% to home loans, the bank must set aside capital equivalent to 50% of your loan amount to cover potential losses. The banks must keep this amount safe, so, to keep this amount safe they usually charge 0.5%-1% to the customer and they include this percentage in the interest rate that is paid by the customer. Lenders charge a risk premium irrespective of RBI’s fixed risk weightage.

Here's how it works:

1. Loan Amount: ₹50,00,000

2. Risk Weight: 50%

Capital Required = Loan Amount × Risk Weight
Capital Required = ₹50,00,000 × 50%
Capital Required = ₹25,00,000

So, the bank needs to keep ₹25 lakhs as a safety net for your home loan. This helps the bank manage the risk and be ready in case you don’t repay the loan.

What is LTV?

LTV (Loan-to-Value) is a measure that shows the ratio of a loan amount to the value of the property being bought. It helps lenders determine how risky a loan is. A higher LTV ratio means higher risk because the borrower is covering a larger part of the property's value with the loan.

Suppose you want to buy a home worth ₹50 lakhs, and you apply for a home loan of ₹40 lakhs. To calculate the LTV ratio:

LTV= Loan Amount / Property Value * 100

LTV in this case= 40 lakhs/ 50 lakhs *100= 80%

This means the LTV ratio is 80%, indicating you are financing 80% of the property's value with the loan and paying the remaining 20% as your down payment.

Before introducing the risk weightage by RBI in October 2020 what was the last weightage banks follow?

Before 2020:

RBI's Revised Risk Weight on Home Loans

In October 2020, the RBI revised the risk weights for home loans based on the Loan-to-Value (LTV) ratio. This change aimed to support the real estate sector by making home loans more attractive and affordable.

Key Changes in the Revised Risk Weight

1. Lower Risk Weight for LTV Ratio ≤ 80%:

• LTV Ratio: Less than or equal to 80%

• Risk Weight: 35%

• Impact: A lower risk weight makes it easier for banks to offer better loan terms for borrowers with lower LTV ratios. This means if you make a large down payment, you'll likely get better terms on your home loan.

2. Moderate Risk Weight for LTV Ratio > 80% and ≤ 90%:

• LTV Ratio: Greater than 80% but less than or equal to 90%

• Risk Weight: 50%

• Impact: This change helps manage the higher risk of high LTV ratios but still allows borrowers to get loans with lower down payments.

Why Should You Care About These Changes?

1.Lower Interest Rates:

Banks can offer lower interest rates on home loans with lower risk weights because they need to set aside less capital. This can save you a lot of money over the life of the loan.

2.Easier Access to Home Loans:

With lower risk weights, banks are more likely to approve home loans for people who might not have qualified before. This helps first-time buyers and those looking for affordable housing.

3.Improved Loan Terms:

Better risk weightings can result in improved loan terms, such as lower processing fees, reduced EMIs, and more flexible repayment options. This means borrowers can enjoy better conditions suited to their financial situation.

Conclusion

The RBI's new risk weight on home loans makes it easier and cheaper to get a home loan. Knowing these changes helps you make better decisions about your loan, whether you're getting a new one or switching from an old one.

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Frequently Asked Questions (FAQs)

1. What is the LTV ratio?

• The Loan-to-Value (LTV) ratio is the ratio of the loan amount to the appraised value of the property.

2. How does a lower risk weight benefit borrowers?

• Lower risk weights mean that banks can hold less capital against these loans, leading to lower interest rates and better loan terms for borrowers.

3. Can I transfer my home loan to a new lender?

• Yes, you can transfer your home loan to a new lender to benefit from lower interest rates and better terms. This process is known as a home loan balance transfer.

4. Are there any tax benefits to transferring a home loan?

• Yes, you can continue to claim tax deductions on the interest paid and principal repayment under Section 24(b) and Section 80C of the Income Tax Act, even after transferring your home loan.

5. When is the best time to transfer a home loan?

• The best time to transfer a home loan is early in the tenure, when interest rates drop significantly, or when your credit score has improved.