If you are planning to buy a house in the short term, LTV Ratio or Loan to Value Ratio is something that is going to add to your misery. RBI (Reserve Bank of India) has come up with a new rule that might derail your short term plans of owning a dream home.
The guidelines issued by RBI simply states that now stamp duty, registration and other documentation fees cannot be included in the total cost of the house.
This means that now banks will offer you a loan of a much lesser amount than what it was before this ruling.
I can tell you that is not good for your financial planning. Let me show you how.
The Loan to Value or LTV Ratio
Let us first understand what the LTV Ratio is so that you can then better appreciate why planning to buy your dream house has become a challenge.
Loan-to-value or LTV ratio is the ratio of the loan amount to the total cost of the property.
So, it can be depicted as below –
LTV ratio = (Total Value of Loan) / ( Total Value of House)
Note that the Total Value of the Loan is dependent on how much down-payment you can contribute from your side.
Let us take an example.
Suppose a property is worth Rs 50 lakhs. Let us compare two scenarios below.
| Scenario 1 | |
| Cost of Property | 5,000,000 |
| Down Payment | 1,000,000 |
| Loan Amount | 4,000,000 |
| LTV | 80.00% |
In Scenario 1, the LTV is 80% as the down-payment is Rs 10 lakhs for a property worth Rs 50 lakhs. So what happens if you increase this down-payment to Rs 15 lakhs.
| Scenario 2 | |
| Cost of Property | 5,000,000 |
| Down Payment | 1,500,000 |
| Loan Amount | 3,500,000 |
| LTV | 70.00% |
This is what Scenario 2 depicts. The LTV Ratio is 70%.
So by increasing your down-payment, you were able to reduce your LTV.
The significance of LTV Ratio
The lender’s decision to give you a loan is based on this ratio.
As the above example shows, the LTV Ratio is lower when the down-payment is higher. And in case the down-payment is lower, the LTV is higher.
Now lenders are in love with real estate investors who can down pay more. That is because your capability to pay more money as down-payment establishes that you are a genuine credible credit seeker and that you will not default. Lenders feel confident that when you pay upfront more money when purchasing a house, you will have the capability to service the EMIs as well.
As lenders like people who can down-pay more when planning to buy a house, such an investor needs to have a lower ratio. So the lower the LTV, the better it is.
In many cases, lenders will ask you to increase your down-payment so that you can be viewed as a person who will eventually not default.
How does the new RBI ruling make matters worse for you ?
Suppose the below depicts the cost of a house worth Rs 82 lakhs with breakup across stamp duty, registration and documentation as shown.
| Basic Cost of Property (A) | 7,500,000 |
| Stamp Duty (8%) | 600,000 |
| Registration (1%) | 75,000 |
| Documentation | 25,000 |
| Total Cost of house (B) | 8,200,000 |
Prior to this ruling, lenders used to take the entire total cost of the house (B) as shown above and then ask you to pay 20% as down-payment. Now that has changed and lenders will now only take the basic cost of the property (A) and ask you to pay 20% as down-payment. This means that you need more money as down-payment as stamp duty, registration and documentation expenses now need to be paid by you and cannot be covered under a home loan.
Check below for the specifics.
| RBI Ruling Effect | Before Ruling | After Ruling |
| Down Payment (20%) | 1,640,000 | 1,500,000 |
| Loan Amount | 6,560,000 | 6,000,000 |
| Additional down-payment | – | 560,000 |
| LTV | 80.00% | 73.17% |
The effect of the ruling is huge. For the property above, you need to shell out an traditional Rs 5.6 lakh !!. Now you know what planning to buy a house entails !
What should you do ?
You now need to save more for the down-payment. Since not all investors can accumulate this extra down-payment in a short amount of time, the plan of buying a house might have to be pushed beyond for a few years. I know that is not desirable, but not everyone has a huge corpus that can be utilized to bridge this gap.
In that extra months/years that you get, save for the delta down-payment. If this is not an option you can go with, then you should probably look at a house which will cost you less than what you planned for. That means moving to the outskirts of the city or booking a house during pre-launch. Both have their own pros and cons.
So while you crib about this new ruling, remember that there is always a silver lining in everything that does not go the way you wish. In this case, by asking for extra down-payment, RBI is forcing you to increase your equity in your house. (What is home equity ?) That means a smaller loan amount and a smaller EMI.
What do you say ?
@Radhey,
It will hurt the pockets of middle-class people, property prices have been sky-rocketed in most of the cities. Unless they regulate the prices(which the builders will not allow) it won’t go down well with the people. I am not happy with this ruling.
Rakesh
@Rakesh, It will hurt the pockets but I think RBI must have had some thoughts before implementing this.
There needs to be a silver lining to this before they would have come out with it.
Thanks Radhey for writing this article. I learnt about LTV ratio 🙂
The idea of RBI seems to be good but it needs some extra support to be practical.
The idea is good in the sense that it will have small EMI amounts for buyers and chances of being a defaulter will also reduce. May be RBI got a huge list of defaulters consistently from banks and to help them RBI came up with this idea.
The extra support it needs is for the government to control property prices. The rate of inflation for real estate is just unbelievable. The new policy is definitely going to hit the buyers because the extra amount is too huge to be readily available. Government must intervene to do some correction in real estate prices as well but the big question is: Are they willing to do it? The short term answer I am guessing is NO.
In my opinion the buyers should start looking for pre launch offers or cheaper options. The wait to save extra money is not going to help as it is difficult to beat the real estate inflation.
The common fear in pre launch offers is whether the project will be completed on time. This is where buyer has to act smart and make sure the sale agreement is written properly. I don’t think many people bother to read the sale agreement as they feel it is too big to read or it has got legal jargon, which they will not understand. One must read the sale agreement [or consult a property advocate] and ensure proper penalty clauses are included for builder as well. Generally builders will put penalty clauses against buyers and nothing against them unless a buyer demands. For instance, you can ask builder to bear your monthly rental as a penalty clause.
What we need to do is stop worrying about this directive as it is out of our control and start looking for smarter options. Let us not waste time on things that are out of our control and focus on what we can control.
@Vivek K, Like your thoughts Vivek. 🙂
@Vivek K, You continue to amaze me with your thought process and contributions here.
Please keep up the good work.
The government is not going to help in any way to control the prices in the short term. I never understand why SEBI is going berserk with regulations on stocks/MFs and nothing is being done about the builder lobby.
Pre launch offers are, as you said, a riskier proposition but then I like what you said at the last –
We need to be smarter with what we have today. That is so important.
You are a breath of fresh air Vivek, keep writing here !
@Radhey Sharma, Thanks Radhey for your kind words. I shall continue to contribute here, you have encouraged me enough. 🙂
@Radhey Sharma, Oh and don’t worry about the regulations. I am hopeful that the way it happened for stocks/MFs and now happening for insurance products, it will happen for real estate too.
@Vivek K, I hope it comes out sooner than later. It is badly needed.
May be RBI’s intention behind this move is good i.e. less loan thus less EMI. But in the time of booming property prices in every metro/non-metro city bearing the cost of higher down payment would be really a big deal for the common people.
Whether RBI does anything in this regard would be the main question.
@Sudip D, Remember there are always buyers for every high flying real estate project. Things do get sold.
If we were in a situation where the builders inventories are piling up thick and fast, then he would genuinely reduce the prices.
I think RBI has done this to reduce speculation in real estate.
@Radhey Sharma, Yea I always wonder from where do people get so much money to waste on over-expensive projects. Some projects I tell you are not even worth buying, the floor plans are so ridiculous that I feel I could do a better job than this so called “certified” architect but alas even such projects are sold out in no time.
Wake up people! 🙂
@Vivek K, There is room for everyone in this dirty world !
Similar is the case in our financial planning industry – there are people who cannot make a financial plan but thrive on sales of products.
@Radhey,
Have to agree with you on this strongly.
I have seen many such people who call themselves financial planners visiting our office during Jan-Feb and selling plans where they get huge commission. When i asked them about term plans they just said that it was the worst plan and you would not get any returns.
I just walk away smiling ……..
@Radhey Sharma, You are right Radhey about financial planners. I was reading somewhere that there are hardly 1-2k CFPs in India. However, there are millions of policy selling agents who have “Financial Advisor” written on their business cards. This term has been used loosely in your industry but thanks to forums like this that awareness and importance of CFPs is increasing. Even I wasn’t aware until a few months ago.
@Vivek K, SEBI is contemplating mandating people to sell just advice or products.
The concept paper is out and I will do article on this soon.
@Vivke,
Agree with you. I have seen people with gross income less than Rs. 5 lacs and buying properties worth 30-40 lacs.
Rakesh