Underwriting Norms Need To Improve For Cheaper Home Loans
To ensure that homes are available to the underprivileged, the government has promoted affordable housing options which can be financed through cheap Home Loans.
These type of loans are taken by first time home buyers who are self- employed or are employed with small companies. Most of them have no banking transactions to verify their credit history nor do they file income tax returns. Loans are made available to them on the basis of assessment of their incomes.
However, relying on a variable factor like income to advance a loan can be a high credit risk for the bank. This is where underwriting is important. Essentially, it helps to protect the service provider against credit risks.
What is Underwriting?
Underwriting has different connotations based on the sector that you’re talking about.
In insurance, underwriting involves the process of agreeing to cover the financial risk that is an inherent element in an insurance contract. But when it comes to commercial banking, underwriting refers to the process of assessing the borrower’s creditworthiness and offer them loans.
The risk in this case is the chance of the borrower defaulting in the repayment of the loan. The fee for underwriting is the interest charged on the outstanding balance.
The Need for a Change in Underwriting Norms
Unlike regular Home Loan borrowers who pay a high Home Loan interest, those in the low income group are privy to lowest Home Loan interest rates.
When a bank or housing finance advances cheap loans only on the basis of an income assessment, there is bound to be an increase in the number of its NPAs.
The advantage underwriting brings to the table is that borrowers get to take up loans at some of the lowest Home Loan interest rates.
Despite the guarantee provided by underwriting, there is a high chance of default in repayments, which exposes the banks and housing finance companies to an increased credit risk.
However, no matter how high the credit risk is when lending to low-income borrowers, banks are not permitted to deny loans.
In the absence of income tax returns or banking transactions, it gets difficult to rate the creditworthiness of a borrower, thus posing a high credit risk to lenders of cheap loans disbursed for affordable housing.
This forces many financial institutions to charge high interest rates to borrowers from other income groups. With revised underwriting norms, the risk incurred by lenders can be reduced drastically.
Financial institutions can also educate their prospective buyers to use a Home Loan EMI calculator. This will give the borrower an understanding of how much he has to repay.
This move can definitely help to reduce the number of borrowers defaulting on their loan.
To conclude, if the underwriting norms are reworked to better suit the conditions of the market, lenders will be better placed to assess the creditworthiness of the borrower.
This in turn will lower the risk of lending to low-income groups and subsequently allow them to offer cheaper loans across all segments.
Category: Loans
