Loan against property: What are the benefits and disadvantages

When it comes to taking a loan for a specific purpose, individuals usually choose between going for a personal loan or a loan against an asset such as a property. There are many advantages of taking a loan against property. But, at the same time, there are some disadvantages. This article discusses the pros and cons of opting for a loan against property.

Before we discuss the loan against property pros and cons, let us start by listing the types of loans and then explore what is implied by a loan against property (LAP).

Types of loans: secured and unsecured

Financial institutions mainly offer two types of loans to individuals:

a) Secured loans

When a loan is offered against the security of an asset, it is known as a secured loan. Common examples of secured loans include home loans (offered against the security of the house property being purchased) and vehicle loans (offered against the security of the vehicle being purchased).

A loan against security (LAS) is another common example of a secured loan. It is usually offered against the security of an asset such as property, gold, shares, fixed deposit, etc. The security offered is known as the collateral. If the borrower is unable to repay the loan, the lender can sell the security and recover the outstanding loan amount. Any additional amount recovered from the asset sale, over and above the outstanding loan amount, is returned to the borrower.

b) Unsecured loans

When a loan is offered without any security, it is known as an unsecured loan. Common examples of unsecured loans include personal loans, credit cards, etc.

What is a loan against property?

A loan against property (LAP) is a secured loan taken by a property owner by offering their property as collateral. The collateral property can be either residential or commercial. The loan amount depends on the value of the property and the loan-to-value (LTV) ratio. LTV is the percentage of the property value that the financial institution can give as a loan to the owner.

The borrower can take a loan against the property for various reasons. The borrower need not specify the reason to the financial institution for taking the loan.

Also Read: What Is Loan Against Property?

The above graphic shows some of the reasons for which an individual may take a loan against property. For example:

• Child’s higher education
• Child’s marriage
• Home improvements or renovation
• Starting a new business or expanding an existing business
• Medical emergency
• Debt consolidation
• Taking a vacation, etc.

Advantages of loan against property

Listed below are some of the key advantages of taking a loan against property:

1) Property use can be leveraged

A loan against property allows you to use a property for some productive purpose. For example, you may have rented out the property and already started earning an income from it. You can leverage it further by taking a loan against it and using the money for some productive purpose, such as starting a new business that can be an additional source of income. Even though you will be offering the property as collateral to the financial institution, the ownership of the property will remain with you.

2) Faster processing

The processing time for a loan against property is lower than what is required for some other loans as it is a secured loan. If the borrower has all the required property documents and other documents in place, the sanction and disbursement of the loan are done quickly.

3) Lower interest rate

The interest rate charged on a LAP (usually in the 8-11% p.a. range) is lower than in the case of other loans, such as a personal loan (usually in the 10-15% p.a. range). LAP is a secured loan, so financial institutions offer it at a lower interest rate.

You can use the above or similar calculators to calculate the EMI payable on a LAP.

Some financial institutions may offer a LAP at a floating interest rate instead of a fixed interest rate. If the market interest rates fall, you benefit from a lower interest amount outgo. Some financial institutions offer LAP as a credit line rather than an EMI-based loan. In such a scenario, you pay interest only on the amount utilised. The interest is charged monthly.

4) Longer loan tenure

Financial institutions offer up to 15 years of tenure for a LAP. This is much higher than what is offered for a personal loan. A longer tenure allows the borrower to repay the loan amount gradually without straining their cashflow. The tenure will depend on the borrower's age, income, and other eligibility criteria.

5) Greater loan amount

A borrower can take a higher loan amount against the property depending on their need and the property valuation. The financial institution will conduct the property valuation and then apply the LTV ratio (which is usually in the 75-90% range). Such institutions may have a maximum limit that they may give under LAP. The loan amount will depend on factors such as property value, LTV ratio, borrower's repayment capacity, credit score, etc.

Also Read: Loan Against FDs. Is It Worth It?

Cons of loan against property

Now let us look at some of the cons of a loan against property:

1) Borrower may lose the property in the event of default

A loan against property is a long-term commitment to pay EMIs regularly on time. If the borrower faces financial difficulty and defaults on EMI repayment, the financial institution may take possession of the property, sell it, and recover the outstanding loan amount. Any additional amount recovered from the property sale is returned to the borrower. A borrower should keep a couple of months' EMI in a separate bank account as a precautionary measure. They will come in handy during times of financial stress.

2) Longer time for loan approval and disbursement if documents are not in place

Earlier, in the advantages section, we saw how LAP can be sanctioned and disbursed quickly. However, this advantage can quickly become a disadvantage, and LAP may take more time than other loans, such as a personal loan, if the property documents are not in place. The financial institution needs to go through all the property documents, get the property valued, etc. If there are issues with the property documents, such as, some documents are missing, or property title is not clear, it can delay the entire LAP process. While these can be time-consuming procedures, banks and NBFCs are taking steps to speed up the overall LAP process.

3) Loan amount depends on property valuation and LTV

The financial institution does the property valuation from their appointed property valuers. Once the property valuation is done, the financial institution will apply the loan-to-value (LTV) ratio. For example, let’s assume that the borrower’s property is valued at Rs 50 lakh. If the LTV is 60% in this case, the borrower will get a maximum LAP of Rs 30 lakh.

4) Floating rate may impact cash outflows in times of rising interest rates

Financial institutions may approve a floating rate LAP. During a rising interest rate scenario, the interest rate will be revised upwards from time to time as market interest rates rise. It will result in a higher EMI outflow when interest rates are increased. Beyond a certain point, the higher interest rates may cause financial distress to the borrower and may even lead to default.

5) Processing fee and other charges

Before signing the loan agreement, ask the financial institution to clarify the amount charged as processing fee and other fees if any. Compare the processing fees and interest rates of a few financial institutions before making a final decision.

Also Read: When Is It A Good Idea To Take Up A Top Up Home Loan?

Conclusion

A loan against property has many pros and some cons. The pros include putting your property to productive use, faster processing, lower interest rates, higher loan amount, and longer tenure. Cons include losing the property in the event of default, loan amount restricted to property valuation and LTV, and having to deal with floating rates in a rising interest rate scenario. So weigh the pros and cons and decide what best suits your needs.