Step Up Home Loans are home loans where the borrower can get a higher amount as home loan as compared to his eligibility. Banks sanction higher home loan than eligibility based on an assumption that the borrower’s salary will increase a certain percentage annually in the future. The Step-up home loans have no standard procedure and are based upon the respective policies of different banks.
In Step-Up loans, lending institutions give different repayment options to its borrowers, wherein the borrower can chose to pay a lower EMI in the first half tenure of the Home Loan and then Step-up the EMIs in the second half or they can chose to pay just interest amount in the initial years and make repayment of principal later.
The borrower’s repayment ability is determined at the time when the bank gives him a loan since banks don't want to lend you an amount that you can't afford to repay. Banks not only check your relationships with banks, your credit report and your repayment history via CIBIL Report, but also calculate something called a FIOR i.e. Fixed Income to Obligations Ratio. Different banks have different parameters. However most of the banks may not give out loans if the FIOR of the borrower is above 40%.
For reference, let take an example where Daya earns a salary of ₹1,20,000 per month and the bank where he's applied for loan requires a FIOR of 40%. Let's take a presumption that no other loans have been taken by Daya at present. The maximum EMI that Daya can afford is ₹48,000. Hence, the bank will not sanction the loan in which the EMI will be more than ₹48,000.
Let’s assume that Daya has applied in a bank that charges 9% Interest rate for 20 years tenure of the home loan. In this case the maximum home loan amount Daya can get is ₹53.3 Lakhs.
What if Daya needs to buy a home which is going to cost him much more than ₹53.3 Lakhs?
Daya may ask for help from friends or family.
He may try to find a Bank that offers less Interest Rate or higher tenure which will bring down his EMI and hence improve the FIOR, thereby a better Home Loan amount could be disbursed.
However, it is quite difficult to get the above two options and that is where Step-Up Loans come to rescue. Banks give a preference to Young Professionals in Step-Up Loans as their potential for getting an increment is high.
In step up loans young professionals can opt to pay just the interest in the initial years and then pay the principal. Your loan eligibility can be higher since only the interest is being paid during the initial period. This way the loan amount also goes higher. Similarly, some lending institutions offer to make EMIs lower in the initial years, which will improve your FIOR and hence will make you eligible to get more Home Loan.
Therefore, young professionals can benefit from Step-Up Home Loans and buy their dream home at a time when their earnings do not match the Home Loan amount needed to buy that home.
What is the Downside of Step-Up Loans?
Step-Up loans are disbursed with higher loan on the assumption that your Salary will be increased. However, given the lay-offs, hire and fire policies and other factors currently prevailing in the market, what if your salary doesn’t increase, what if you don’t get your much expected increment? Then you will end up in stress and a tight financial position as you’ll be paying for the interest as well as Principal amount from the same salary.
Also, on paper calculations show that as compared to a regular home loan, you end up paying higher interest on Step-Up loans.
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