Banks grant loans for buying a property. The idea of private property is a hallowed one. The individual and society believe that the goal is – a roof of one’s own. To make this possible loans are being readily offered.

In loans two things are important. Is the person capable to repay the loan with untainted credit history? The second point is the collateral. The borrower loans the amount but retains the right to repossess the property incase the borrower trips. Thus the house is offered as collateral or security. The most famous security kept by a lender was a pound of flesh in Shakespeare’s The Merchant of Venice!

The principal is the loan amount. The borrower repays it in installments, staggered across years to make the load of repayment easy. Over this an interest is paid for the money taken. As the repayment of capital proceeds the interest declines. In one agreement the interest is fixed. In another the interest floats with the market rates.

Lenders negotiate with primarily two types of borrowers. Ordinarily a borrower has to show his bona fides – capability and credit history before being granted a loan. Since many do not qualify, a way out was introduced in sub-prime markets where the initial interest was low and records regarding past credit history and income were overlooked. The idea was to give a good section of the have-nots in the population a share of the cake. But it misfired. On the one hand the borrowers were either greedy or ignorant. They did carefully read terms. On the other hand lenders knew very well that the borrower would never be able to sail through the mortgage for more than a year or two.

The equity is the value of the property after deducting all claims on it by way of loans, lien etc. When a loan is taken the market price of the property is stated. The equity of the house must cover the loan amount. In real terms it means that if the borrower fails to redeem his pledge then the bank can realize the amount by taking possession and selling the property. The loan is backed by the equity of the property involved. Fraudulent practices lead to false appreciation of property value. The loan paper gets passed but in time of a crisis when the bank will try to sell it to repay the debt it might be found that the real value does not cover the loan. The result is that the house goes but the entire loan does not. In a lucky case if property prices raise the borrowers would be able to sell the property, clear loans and invest in another unit.

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