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Being a homeowner is a milestone that most Indians look to achieve. Some achieve this by buying a home that is being developed or one that is ready to occupy. For still others though, the homeowner dream includes building a home from scratch. One that follows their specifications.

While you know that a home loan will provide you with the funds required to purchase a home, to build your own home you will need to apply for a construction loan.

Difference Between Home Loans and Home Construction Loans

It is important to understand that a home loan is not the same as a home construction loan. Apart from the fact that the funds help you become a homeowner, these two loans are very different.

Home loans are generally easier to apply for when compared to home construction loans. While applying for a home loan, you need to provide basic identity-related and income-related documents. Property papers that you have to provide will be provided to you by the developer.

When it comes to home construction loans, though, the paperwork is quite extensive. In addition to identity and income-related documents, you will have to also provide property papers, a document from the local civic body or municipal corporation authorising construction on the plot, and a blueprint of the proposed construction or a construction map from an authorised architect or civil engineer. Additionally, you will also have to provide property tax papers and any other document the bank may require.

The second difference is with respect to the loan tenure. Since the amount you end up borrowing for a home loan is quite high, the tenure for home loans is long. This helps you spread the EMI over a number of years. You can take home loans for tenures extending to 30 years. This isn’t the case with home construction loans though. The loan tenure is usually much shorter and is up to 10 or 15 years. This means the EMI will be much higher.

Thirdly, when it comes to options, you may not find many when it comes to home construction loans. You can apply for a home loan from banks or non-banking finance corporations. With home construction loans though, you may find that you don’t have too many options to choose from.

Next, when it comes to the down payment, you have to pay at least 25% of the value of the property as down payment. This value is lower for home loans.

Then you have the interest rate. Interest rates on home loans currently range from 8% p.a. to around 12% p.a. Home construction loans generally have higher interest rates. It starts around 11% p.a. and can go up to 14% p.a. or more. The interest rate also depends on the type of property on which you are constructing your home.

Lastly, the loan disbursal process is quite different. With home loans, the entire amount is disbursed. With construction loans, on the other hand, the money is disbursed in phases.

How Are Home Construction Loans Sanctioned?

As mentioned earlier, home construction loans are disbursed in parts. This is similar to how home loan funds are disbursed if the home you have bought is still being developed. With home construction loans, however, you will first have to bring proof of your contribution, submit photographs, and get a certificate from a civil engineer or an architect describing the house’s stage of completion.

At times, the bank may send their own person to do checks on your home before funds are disbursed. Usually, loans are disbursed in 2 to 5 instalments. So, you will have to make sure that you have enough money to purchase raw materials required for construction even if the loan instalment hasn’t been received yet.

What Is the Disbursement Process Like?

If you take a loan which is 85% of the cost of construction, the first instalment will be given to you only after the foundation has been completed. The second disbursement is made after the completion of the lintel level (portion between the top part of the window and the top slab), the third instalment is provided post the completion of concrete work, and the final instalment is provided once 90% of the construction has been completed.

But what happens if you take a construction loan which is 50% of the construction cost?

In such cases, you may receive the first instalment only after you reach the lintel level or the concrete work has been completed.

The reason banks decide to disburse the loan in instalments is because the property does not exist yet or is still under construction. So, ascertaining the loan-to-value ratio is quite difficult.

Keep in mind that disbursal of instalments is linked to the construction of your home. Any delays in procuring raw materials could lead to delay or suspension of construction and in turn a delay in loan disbursal.

What about EMI Payments?

With a home loan, you generally service interest during the moratorium period and then start paying the EMI post that. This is not the case for home construction loans. For these loans, you will have to pay a pre-EMI until the last loan instalment has been disbursed. This pre-EMI is the interest you pay on the amount you have used.

Another thing to consider about pre-EMIs is that the payments you make don’t go towards reducing the principal. This means a delay in construction even for a few months could result in you paying more pre-EMI.

A good rule of thumb is to switch to paying EMIs if you have withdrawn around 70% to 75% of your loan. Of course, this is provided your bank allows you to switch payment modes before the disbursement of the last instalment.

What Else Do You Need to Know about Home Construction Loans?

1. Deviation from the Proposed Plan During Construction

Let’s say that mid-construction you decide to change the plan or the layout of your home, you will find that your loan will be frozen by the bank. This is because before your loan is sanctioned, you provide a blueprint to the bank along with an NOC from your local civic body. Changes to the blueprint mean that those authorisations no longer hold good. Hence, you will have to get additional approvals for any changes you plan to make if you want the bank to release funds.

2. Tax Benefits

You will not be able to enjoy tax benefits until the construction has been completed. You can claim tax benefits up to Rs.2 lakh per year on the interest you have paid during the construction phase. This can be done by aggregating the interest amount and dividing it into 5 equal instalments from the year the construction has been completed. However, note that if your property is not constructed within 5 years of the loan being sanctionioned, your total claimable interest amount will be reduced to Rs.30,000 per year.

If you have paid pre-EMIs, you can claim tax benefits on the interest paid. This too can be done only after completion of construction.

3. Exclusions

When you buy a home from a builder, any interior work such as kitchen cabinets and built-in cupboards that are part of what the builder provides will be covered by your home loan. You will have to pay only for any additional interior work you request for. This is not the case with home construction loans.

The cost of all interior work will have to be borne by you. And seeing that even minimal interior work can cost anywhere from Rs.3 lakh onwards, make sure you have enough money to take care of these expenses.

In fact, you should read the home construction loan agreement carefully before signing so you know exactly what is included and what is excluded.

At the end of the day, if you are looking to build a home from scratch and not just buy a home, a home construction loan is the way to go. Before you do apply for the loan, though, make sure you have all your documents in place and enough and more money for the down payment and the interiors.

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