It is a common belief that banks offer different home loan products for self employed and for salaried individuals. Let’s take a look where the difference really lies.
Home loan products
Banks and Housing finance companies offer home loans in 2-3 basic categories:
Floating rate home loan
Fixed rate home loan
Home loans with flexible eligibility and flexible repayment options
The basic floating rate home loan and fixed rate home loans that are offered to salaried individuals are also offered to self employed.
However, the income and risk profile of a self employed individual are very different from a salaried individual. Banks understand this. So if you are self employed or a professional with an independent practice, your home loan application will be evaluated in a different light.
Home loan application of self employed Vs salaried
Whether you are a small shop owner or run a high value business, your income depends on the business. If the business is successful, you will have a steady income every month. If the business is seasonal or prone to losses, then your income will not be as steady.
This will directly affect how well you can repay your liabilities. So banks have to make sure they evaluate your income, assets and other liabilities before they sanction your home loan.
Let’s take a look at the differences between home loan application of self employed and home loan application of salaried individual.
Calculation of income
When a salaried person applies for a home loan, it is pretty simple to calculate his income. Usually one look at the bank statements and income tax returns will give all the details and proof.
But calculating income is not so simple in the case of those self employed. Here are some examples of self employed and professionals who apply for home loans:
Shop owner earning income in cash, receipts available
Doctor earning professional fees in cash, no receipts available
Large business with multiple partners sharing income
Consultant claiming expenses against income’
Rickshaw driver with cash income and no proof
Tailor with cash income, receipts available
Banks and housing finance companies use different methods to calculate and estimate income for all these different cases. For some, actual net profit is used, for some a fixed percentage is taken. For some professions like Doctors, banks take a multiplier number and use it to estimate annual income. Each bank follows its own fixed profit percentage and multiplier. The numbers are based on risk assessment models developed by banks internally. Since income may not be consistent, banks even look at total yearly income, subject to minimum number of deposits/transactions.
Documentation for salaried individuals is quite simple and clear cut. Most of the information is available in Form 16, Form 16 A, Form 26AS (Traces) and bank statements.
But with self employed documentation is never as clear. Each business has different challenges. Most of the time, ITR and bank statements don’t reflect all the income and liabilities. Sometimes income documents may not even be available. In fact, whether you are salaried or self employed, if you don’t have documents, you will still get a home loan. However, banks offer specific products for such applicants. The interest rate is considerably higher for these products.
So banks have to take a number of supporting documents and cross check every piece of information on the home loan application.
The bottom line is, if you maintain a good record of your income, file your returns and try to route most incomes through banks, you will not have much of a problem in proving your income and assets when you apply for a home loan.
Liabilities to income ratio
As the name suggests, one of the important things banks like to check is – what proportion of your income have you committed to fixed loan installments. This is calculated on income on papers. There are different technical terms for this – FOIR (fixed obligation to income ratio) EMI/NMI ratio etc.
Banks understand that self employed and professionals have different sources of incomes. The nature of cash inflow is very different from salaried individuals and not everything can be based on statements. So based on experience, banks consider different FOIR for self employed and salaried home loan applicants. If the applicant is running a steady business and has a good CIBIL score, banks will even ignore small loans that may end in the next 12 months.
Home loan interest rate
It is a common misconception that banks don’t trust self employed home loan applicants and so they are charged higher interest rates. This perspective is not true.
Banks want to give loans to more and more customers. But they can not afford to be reckless about it, given the amount of funds involved. So, whether you are salaried or self employed, banks always want to make sure you can repay your home loan.
It is true that due to the nature of risks involved in a business, banks used to charge higher interest rates to self employed people. But that is not so much the case these days. In fact some banks do not charge different interest rates to self employed and salaried.
Instead, they charge higher interest rate for different reasons – if you have low CIBIL score, if your loan value is beyond a certain percentage, if you do not have all the required income documents etc.
Gone are the days when it was difficult to apply for a home loan for a self employed individual or professional. Banks these days are more than willing to offer loans to all segments of applicants. But you stand a chance to benefit most, if you take care of basics like – maintaining a good CIBIL score, maintaining proof of income, filing your returns etc.
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