Manoj Patil, a 37-year-old is a self-employed architect from Pune. In September 2016, he decided to buy a house, but getting a loan from a bank was not easy. He had approached about five different banks before State Bank of India finally gave him a loan of Rs 38 lakh in July 2017, against his loan application of Rs 50 lakh. The other banks didn’t find him credit worthy. Manoj had delayed his equated monthly instalments (EMI) on his car loan a few times before. Banks don’t view any skipping of EMIs kindly, especially if you approach them for a loan, and being self-employed only added to Manoj’s woes.
Loan sanction not smooth
His newly-formed company seemed unstable to another bank. Since start-ups take time to show profits, the initial years are a struggle. Lack of skills in running the business successfully for long term, the firm not being registered under the Goods and Service Tax (GST), fluctuating income and inadequate bank balances were some of the other reasons banks gave him while rejecting his application.
“The lenders were suspicious about me and remained unconvinced with all the income proofs that I had submitted.” He felt the home loan process was more stringent and lengthy for him compared to what the process was for the salaried home loan applicants, as he was self-employed.
To entrepreneurs, financial institutions ask for the following key documents while processing home loan applications: personal identity proofs, savings and current account bank statements of the last six months, permanent account number (PAN) card, educational and professional qualification certificates, residential address proof, last three years’ ITRs(income tax returns) and audited financial statements (attested by a chartered accountant) and proof of the business’ existence.
Now, with technology to evaluate loan applicants’ profile, things are improving for the self-employed. Financial institutions are looking to tap an under-served market. The demand for home loans from the self-employed segment is growing across cities. So, now we have several banks and housing finance companies offering home loans specifically designed for the self-employed. The loan tenure is also enhanced for those with their own business. For instance, PNB housing finance is offering home loan to self-employed for 30 years.
Professionals are favoured
Meghana Thakur is a 31-year-old jewellery designer from Mumbai. In April 2018, she applied for a home loan of Rs 35 lakh in a private sector bank. The bank rejected her loan stating that it doesn’t offer home loans to self-employed non-professionals. She understood that financial institutions prefer lending to self-employed professional categories such as doctors, chartered accountants, company secretaries, lawyers, and engineers. This is because they have specialized skills, domain knowledge and, most importantly, a steady income source.
Other categories of self-employed non-professionals, which include working in jewellery, real estate sectors, trading, contractors, consultants / advisors with commission income, etc. find it difficult to get a home loan. Gaurav Gupta, the co-founder and CEO of the online aggregator of financial products and services MyLoanCare.in explains, “Self-employed non-professionals working in cyclical sectors have fluctuating monthly incomes from their professions. The probability of default on loan repayments is high. So, lending institutions reject home loan applications or offer loan at higher interest rates.”
Company stability and tax returns critical
A couple of banks had rejected the home loan application of Manoj Patil, citing the instability of his company and depressed financials. The lender basically checks for the stability of the company by examining the financials when you apply for a home loan. Sukanya Kumar, Founder & Director of home loan advisory firm, RetailLending.com says, “The Self-employed need to establish their company (business) for a minimum of three years with at least two years of ascending profits lately before applying for home loan.” Otherwise, the loan assessor at the financial institution will reject the home loan application at the initial stage itself.
In the case of start-ups with no profits to show, there are challenges getting a home loan approval despite funding from venture capitalists in the business. Banks don’t incorporate source of funding to operate the business while accessing the loan application nor do they rely on future profits from the business. Your business must show growth in cash profits, revenues and tangible net worth in the past three to five years at the time of applying a home loan.
To verify your income, financial institutions ask for past two to three years’ income tax return (ITR) statements.
The importance of a good credit history
A bad credit history can come to haunt you at a later date. Banks evaluate your credit report while making a lending decision. Your credit score serves as a simple tool for you to understand whether you meet a lender’s requirements.
Not all financial institutions reject the home loan application from self-employed with low credit score of less than 650. Denny Tomy, Business Head at loan advisory firm, theloanguru.in says, “If you are able to convince the loan assessor with monthly cash-flow and stability of the company with net income and profits, the home loan application could be processed.” There are a few lenders who may offer a home loan at a lower credit score to the self-employed, but that comes at fairly high interest rates.
In a credit report, financial institutions do not rely on credit score alone, but also look at repayment history of credit card dues and other loans, bad accounts, i.e., if any credit account is settled with writes off by the institution. These write offs are reported in your credit report when you settle with a bank in case you can’t repay a loan. Repay the written off amount mentioned in the credit report to improve your credit score before applying for a loan.
Financial institutions estimate the ability to pay EMIs by calculating your fixed obligations to your net monthly income, commonly known as fixed obligation to income ratio (FOIR). Self-employed applicants should remember that, for an existing loan, the financial institution will likely adjust the eligible loan amount against the prevailing FOIR, which ranges between 50-60 per cent. Shaji Varghese, Executive Director and Business Head, PNB Housing Finance Ltd says, “In case the EMI expense percentage is more than required, it is advisable to close any ongoing short-term loan such as a car or personal loan.” This will enhance the sanctioned amount significantly.
For instance, Ushma Jaju, 39, a lawyer residing in Indore, has an average monthly income of Rs 60,000. Considering 50 per cent as fixed obligations, she can pay up to Rs 30,000 towards her debts. She has two ongoing loans (car and personal) with EMIs totalling to Rs 12,000. Therefore, the disposable income for her is Rs 18,000. Now, if she applies for a home loan, she will be able to avail an amount subject to her repayment capability from the monthly disposable amount of Rs18,000.
Being self-employed, you can improve your chances of getting a home loan if you are willing to make a higher down payment while purchasing a home, show substantial savings and have a good credit score. It is important to build an income profile in a manner that can make you eligible for a home loan. This includes regular ITR filing, showcasing a stable and adequate income stream.
One of the key reasons for rejection could be that the institution may have evaluated your repaying capacity negatively. So, improve your cash-flow and approach the financial institution again.