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6 Things to note while applying for house construction loan

House construction loan and home loan are different. The home construction loan‘s rules before and after approval and the tax benefits are complicated and can throw up many surprises for the borrower.

Adhil Shetty

Aman, a businessman who hated the high rise culture, preferred to construct a house in his home land. He had purchased a plot, and because of the rising real estate prices, had to stretch beyond his budget for it. With limited funds left, he was not in a position to start construction on the plot.

Aman applied for a home construction loan. He was under the impression that on sanctioning the loan and upon completion of all legal formalities, the bank would grant him money for starting construction work. But, Aman was surprised when the bank asked him to come back after completion of lintel level of the house.

Many people who apply for home construction loans are unaware of its complete terms. Here’s what you should know before approaching a bank for a home construction loan.

Loan disbursement in a construction loan happens in installments only.

If you are expecting that the bank would offer you a lump sum towards your home construction expenses, you may be in for a surprise. The loan disbursement in home construction loans happens only in installments.

The approved loan amount will be disbursed anywhere between 2-5 installments, depending on the progress of construction, loan size and loan to value ratio (LTV). So, borrowers will have to ensure that they have adequate funds to purchase raw materials and to start the construction work.

Disbursement is linked to construction progress

Banks have a pre-determined criterion for disbursing funds according to the progress of the construction activity. For example, if one takes up to 85% of the estimated construction cost as loan, the first disbursement will happen only after completion of foundation work, assuming that 15% of the estimate cost goes for it. The second disbursement will happen at lintel level, the third after completion of concrete works and the final when 90% of the construction activity gets over.

But if one takes only 50% of the estimated cost as loan, the first disbursement may come only after completion of lintel or when the concrete works gets over. Since the disbursal of this loan is linked to the construction activity, if the work gets suspended or delayed, further disbursements will not happen.

You will have to pay Pre-Emi until final disbursal

For a home construction loan, you will have to keep paying Pre-EMI monthly, until the final loan amount is disbursed. This means, you will need to pay interest for the amount getting disbursed under each installment and this amount will not go into repaying the principal loan amount. If you are suspending the construction activity for some time due to any reason, you will continue paying interest to the bank, which is not beneficial in any way.

Let us assume that you are opting for a home construction loan of Rs. 25 Lakh at 10.5% interest rate and the bank has disbursed only Rs 5 Lakh as per the construction status. You will need to pay Pre-EMI for the disbursed amount, which comes to around Rs.4375/- per month. So in a year, you will have to pay an interest of Rs.52,500, which does not go into repaying your loan outstanding.

Any variations from the approved plan are excluded

Before approving any construction loan, the bank seeks various documents including sales deed, approved plan, NOC from the municipal / corporation authorities etc. If you are making any changes from the approved plan like violating the boundaries, extension beyond approved area etc, the bank will not release its funds and holds the right to freeze your loan.

You will have to take additional approval for any deviations taking place from the approved plan or with the construction estimate submitted to the bank.

Limited tax benefits

Unlike regular home loans where you can avail tax benefits on both interest and principal amount, for a home construction loan you will get tax benefits only for the interest paid if the construction activity is not complete.

This means, if you are opting for Tranche EMI option, ie, the option for starting your EMI after the first installment, you will not get tax benefit for the principal portion paid against the loan, until the construction gets over and the bank certifies that they have disbursed the full loan amount.

Any interior works are excluded

Loan for home construction will be provided only for immovable works conducted for a house. This means interior works like painting, furniture, cupboards, kitchen cabinets, partition works, plumbing, lighting etc will not be funded.

Nowadays, the interior works of any small home cost a minimum of Rs 3-4 lakh, and can touch any level on the higher side according to your luxury preferences. So make sure you check with your bank about the exclusions in the loan.

Knowing all the terms of a home construction loan is crucial in avoiding last minute surprises and cash crunch, as home construction involves significant involvement—both physically and financially.

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