The word ‘Margin’ has multiple meanings. In trading percentage of profit is known as margin. The amount we have deposited with the equity brokers is also called margin. When you approach a bank or NBFC for loans like home loans, education loans, personal loans, etc., they do not finance 100% of the value of the items/property to be purchased. Financial institutions lend a certain percentage of the purchase value of the item or house property and ask the borrower to pay the balance amount from his own source. The funds arranged by the borrower from their own source being the difference amount of bank loan and purchase cost is known as margin or down payment.
Assume, you are buying a house for Rs.10000000 (Rupees One Crore). Your Bank agrees to finance Rs.75 lakhs for this and asks you to arrange for the balance amount of Rs.25 lakhs from your own source. The balance amount of Rs.25 lakh arranged by you is known as Margin Money or Down Payment.
How does it work?
In the above case, while releasing the loan, you will be asked to deposit your contribution of Rupees Twenty Five Lakh (Say 25% of the total cost) to the SB/CD account maintained by you, and the Bank also credits loan proceeds of Rs.75 lakh to the same account. Subsequently, the bank debits the total amount of Rupees One Crore from your account and issue a DD for Rupees One Crore in favour of the seller towards full and final settlement in terms of agreement for sale. Here, Rs.75 Lakh is the loan amount financed by the lender, and the remaining Rs.25 lakh you have arranged from your own source is known as Margin or down payment.
The margin money acts as a sign of trust between the lender and the borrower. The Lender treats margin/down payment made by the borrower as a sign of commitment. When a borrower provides a higher percentage of margin, it reduces the credit risk of the lender. Since a higher percentage of margin amount reduces the principal loan amount, it reduces the aggregate interest burden to the borrower as well as reduces the EMI amount or reduces the loan tenure.
Note: Margin money required for loans under construction properties depends on the stage of construction of the property. The borrower need not provide the entire required amount of margin in one shot before the release of the loan. As the loan will be released in parts at each stage of construction, the borrower can provide the proportionate margin for the loan as and when released.