Step-Up Home Loans are specialized home loans where borrowers usually get a higher home loan amount in comparison to their overall eligibility. Banks sanction this higher loan amount, which is based on the assumption that the salary of the borrower will increase by a certain annual percentage in the future. The Step-Up home loans do not have any standard procedure and are based on varying policies across different lenders. In these loans, various repayment options are provided to borrowers.
Borrowers can choose to pay a lower amount as EMI in the first half of the home loan tenor and then increase the EMIs in the second half of the loan tenor. They can choose to pay only the interest component in the first few years of the home loan and then repay the principal amount later. The repayment ability is assessed when the bank provides a loan to the borrower since banks will never want to lend an amount that the borrower cannot repay. Banks will check your credit report, repayment history and also calculate the Fixed Income to Obligation Ratio or FIOR. There are varying parameters used by different banks in this case. Most of the banks may not provide loans in case the FIOR crosses 40% for the borrower.
Suppose a young professional earns around Rs.1,20,000 per month and the bank requires FIOR of 40%. Now, assuming that the professional has no other loans, the maximum EMI that he/she can afford is Rs.48,000. As a result, the bank will only sanction the loan where the EMI will be a maximum of Rs.48,000. Assuming that the borrower applies to a bank where the interest rate charged is 9% and the tenor is 20 years, the maximum loan amount that he/she can get is Rs.53.3 lakhs.
In case a higher loan amount is needed, he/she may try and find a lender where there is a higher tenor or lower interest rate which will improve the FIOR and lower the EMI, thereby increasing the chances of getting a higher loan amount. This is a difficult thing to accomplish and here is where Step-Up loans can prove handy. Banks prefer young professionals for step-up loans due to their high potential chances of earning increments. Young professionals mostly choose to pay only the interest amount in the first few years and then repay the principal. The loan eligibility can also be higher since the interest is only being paid in the initial years. The loan amount will thus be higher. Several lenders may also have lower EMIs for the first few years and this will make the borrower eligible for a higher loan amount by way of an improved FIOR.
Young professionals can profit from Step-Up loans and buy their dream homes even when their current earnings do not match the amount that they need for the purchase. However, there are some disadvantages that you need to keep in mind as well. Step-up loans are sanctioned with higher amounts on the assumption that one’s salary will increase over the future. However, in case your salary does not increase or you do not get that expected increment, you will be in a financial mess since you will have to repay the principal amount and interest component together in the future. In the current scenario where hire and fire policies or lay-offs are increasing, it is wise to reconsider the move. Also, one usually ends up paying more interest on a Step-Up home loan as compared to a conventional home loan.