Step-up home loan

A step up loan is a home loan given by a bank/lender to a loan consumer, based on the assumption that his salary will increase a certain percentage annually.

This kind of a home loan is known by other names by different banks such as Flexi Loans, SURF, Max Money etc,

This kind of a loan offers varying Equated Monthly Installments (EMIs) spread over the loan's tenure. So, the EMI could be lower in the initial years and then increase with years.

Public sector banks like Union Bank of India offers such schemes where they don't give loan amounts, but give an option to pay lower EMI's initially.

Under a step-up loan, the loan amount eligibility may increase. The repayment facility of this loan is structured such that it allows the loan borrower to decide whether he wants to pay a higher EMI in the first half of the loan tenure or in the second half.

The loan eligibility for this loan is calculated based on the projected/expected increase in the income in the subsequent years, rather than your existing salary.

Usually, a person with a potential of better job prospects and educational qualification is more likely to be considered for such a loan, given the loan repayment structure.

The repayment structures differ. The loan tenure will be divided into three phases- 1-2 years, 3-10 years (or 3-7 years) and 11-20 years (or 8-20 years).

This kind of a home loan is best suited for the younger generation of loan consumers who may be first-time or second-time home buyers and for those who want to utilise the tax benefits available on a home loan to the optimum, when their salaries rise.

Professionals like MBAs/CAs are a popular choice for step-up loans because, even though they begin with lower salaries, their salaries increase significantly in the latter years of their career.

There are some short-comings of the step-up loan.

Step-up loan is a borrowing and does mean increase in net cash outflow.

Given the premise on which the repayment structure is based, step-up loans are generally available only to salaried individuals and professionals; and not businessmen.

Let's consider a working example:

The loan eligibility is calculated based on the lower installment in the earlier years thus leading to larger eligibility for the same amount of income.

The installments for a 20 year loan for Rs. 1 lakh at 9 per cent per annum are as follows:

Years 1-3 -Rs. 750

Years 4-20 -Rs. 959

The loan eligibility is calculated as follows:

For a monthly income of Rs.15, 000, Loan eligibility in lakh = 7500/750 = Rs.10 lakh

Here, the bank is dependent on your income-raise in the future to enable you to pay off the increased monthly installment from the 4^th year onwards.