Loan : 20 L – Property Value – Rs. 65 L Why do Banks still Need Income Documents?

Anant Kumar, a well-established surgeon with a roaring practice urgently needed a loan of Rs 20 lakh recently, to buy a bargain distress sale property costing around Rs 65 lakh.

Kumar approached a leading bank for a home loan.

Considering his credentials, banks took up his application. The process began with the submission of documents which included identity proof and proof of residence, besides regular documents required for a home loan.

The real shocker was mentioned in the list of documents required as proof of income in the list given by the bank. A surprised Kumar shot back “If I am mortgaging the house worth Rs 65 lakh, why am I being asked for income proof for a loan of Rs 20 lakh only?”

True. Where is the need of income proof when he is giving a security of over three times the amount of loan?What could be the logic behind this?

Let’s find the reason.

It is the difficulty in re-possessing the property and the relative illiquid nature of property which makes income proof necessary. In a property loan, the possession of the property remains with the borrower. It is not going to be easy for the bank to first re-possess and then sell Kumar’s house to recover the loan if he defaults. Therefore, he needs to produce documents which show that he has a steady income stream.

But why would a bank find it difficult to get possession of and sell the house? First, the bank may not find it easy to evict existing occupants from the house before selling it, as it needs to follow a legal process to get vacant possession of the house.

This has become relatively easier with the SRAEFESI Act, but the occupants (including the borrower) can and many times, do create several legal hurdles in the process of vacating the house. It is only after getting vacant possession that the bank can sell the property to recover its money.

The scenario would be very different if the security is a liquid asset such as equity shares, or for that matter, gold.

In the above example, if Kumar had offered to pledge his shares in a blue chip company worth Rs 65 lakh for the loan of Rs 20 lakh, he would not have had a problem in getting this loan, even without any income documentation.

Since pledged shares are in the control of the lending bank which can with one single act sell these security without any hurdles from the borrower immediately, a borrower’s credit limit is not restricted by declared income as the bank has immediate ability to recover it’s money. Thus, in such case, the borrower can get a certain percentage of the value of the shares (usually around 40-50%) value as a loan irrespective of his income.

The same holds true for pledging gold jewellery which remains in the physical custody of the bank and thus, can be easily sold to recover the money. In both the cases, the bank does not have to take expensive and time-consuming legal help to possess the security. It is readily available with the bank for selling and liquid money can be raised in a short time.

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