Types of mortgage loans: an overviewJanuary 22, 2022 . Financial planning . 10 min read
Are you considering taking a mortgage loan to buy a new home or a residential property? What are your options? In this post, you will learn different types of mortgage loans available for you, based on your need.
A mortgage loan is a loan that you take to purchase a new home or a piece of land. You can also take a mortgage loan to purchase different types of real estate properties, or even to extend an existing property.
Once you have taken the loan, you can repay it to the lender in a series of monthly payments. These individual payments include a part of the principal amount and the interest. These are called EMIs. Different EMI options are available for different types of mortgage loans.
In India, there are multiple types of mortgage loans available. Here is an overview of each of them.
1. Mortgage loan against property
This is also called LAP (loan against property) and this is available both for commercial and residential properties. For this type of mortgage loan, you need to own a property that you can mortgage, or present it as a surety. You will need to submit your original property documents to the lender and the documents will remain with the lender till you have paid the complete amount including interest.
2. Fixed rate mortgage loan
This type of mortgage loan is offered at a fixed rate of interest. The advantage of this type of loan is that you always know your loan liability and you can do financial planning accordingly. For example, you know that even after 15 years how much amount you will be paying per month. This enables you to give a fixed monthly instalment no matter what the current market rates for taking a mortgage loan are.
3. Simple interest mortgage loan
In this type of loan, your interest is calculated on daily basis. This is different from your interest rate is calculated on monthly basis, which is the norm. In the simple interest mortgage loan category, your daily interest is calculated by dividing the interest rate by 365 days and then multiplying the result by the outstanding mortgage balance. Then to pay your monthly interest, you can multiply this number by the number of days in the month. Based on the calculation, you may end up paying more interest this way, than paying on a monthly interest type of mortgage loan.
4. English mortgage
Under the English mortgage loan agreement, the person who borrows the money agrees to transfer the property to the lending party if the loan is not repaid till a particular date. It doesn’t mean the property is permanently transferred to the lending party. If the borrower pays the amount in full, the property is again transferred back to the borrower.
Below are the basic characteristics of an English mortgage:
- The borrower agrees to repay the loan on a specific date
- The mortgaged property is absolutely transferred to the lender
- The absolute transfer is made basis the condition that the lender will be re-transferring the mortgaged property to the borrower upon payment of the loan amount.
- While the possession rights remain with the mortgagee, the mortgagor is allowed to either occupy the property himself or rent it out.
5. Usufructuary mortgage loan
Usufructuary mortgage loans are popular in rural India. Since usufructuary is an uncommon term, it requires a small explanation. Usufruct is a combination of two Greek words usus and fructus. Usus means the right to utilize property in its current form without modifying it or harming it, and fructus means the right to enjoy the fruits or the products of the property being used during the mortgage loan.
Unlike the usual mortgage loan against a property where merely the documents of the property are handed over to the lender, in the case of a usufructuary mortgage loan, the entire property is handed over to the lender so that the lender can utilize the property for financial gains. The property is given to the lender for a specific number of years and there is no liability on the borrower. Normally it is up to the lender to make good on the loan he or she has given to the mortgagor.
6. Variable or floating rate mortgage loan
Contrary to a fixed-rate mortgage loan in which your mortgage remains the same no matter for how many years you pay it, in the variable or floating rate mortgage loan, how much EMI you pay every month depends on the repo rate quoted by the Reserve Bank of India. Repo rate is generally the interest the RBI charges from banks in case the banks take a loan from the Central bank. The interest rate depends on the performance of the economy and the stock market of the country. It is also up to the discretion of the RBI to set the rate.
A good thing about a variable or floating rate mortgage loan is that if the rates come down, your EMI is reduced. On the flip side, if the rates go up, so will your EMI.
7. Adjustable-rate mortgage loan
In this type of mortgage loan initially, the rate of interest is fixed and then it begins to correspond according to the fluctuations in the economy. Depending on whether someone takes out a loan when the interest rates, in general, are low, or the initial low-interest-rate the lender opts for, in the case of adjustable-rate mortgage loans, it is often easier to get the loan and pay the installments. The person taking the mortgage loan may get a lower interest rate than prevalent in the market. The downside is that the interest rate and consequently, the EMI, may increase substantially over a period.
Aside from these types of mortgage loans, there is a sub-prime or some mortgage loan that is offered to borrowers with a poor credit history. Naturally, the interest charged on such a loan is higher.
Taking a mortgage is a long-term commitment: you will be paying EMIs for years to come, sometimes even 25-30 years. Based on your financial planning and financial situation, it is important that you carefully study all types of mortgage loans available to you, and then take a calculated decision particularly suited to your situation.
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