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Switch or reset, to reduce your home loan EMI

Radhika Merwin | Updated on January 07, 2013 Published on January 05, 2013

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With no prepayment charges on floating rate loans, you can switch to a new lender offering a lower rate or convert within the same bank to a lower interest rate.

Are you stuck with a high EMI (equated monthly instalment) on your home loan? Maybe it’s time to take a re-look at your existing loans. With many banks announcing base rate cuts and reduction in home loan rates, you may be able to free up some cash if you scout around for better deals.

Base rates and your EMIs

Let’s say that your outstanding loan amount is Rs 40 lakh with a remaining tenure of 15 years. Your current floating rate is 11.5 per cent. If the base rate is reduced by 50 basis points, the new interest rate will be 11 per cent. This saves you an interest of Rs 2,27,520 over the remaining duration of your loan. (Refer to the table for interest savings under different scenarios.)

By default the banks reduce the tenure and do not change the EMI. In this case, the tenure would reduce by almost a year. Hence, your EMI would practically have remained constant through the year in spite of base rate cuts.

Now before you cry foul, it may be wise to look past your immediate discomfort.

After all, in the long run you have saved some money on interest. You also have the option of asking your bank for a revised repayment schedule, and decide on your options.

If you can afford to pay the higher EMI, you should opt for a reduced tenure. Else, you may choose to lower your EMI and instruct the bank accordingly. In this case, be ready to undertake some additional paperwork for change in ECS mandate etc. for which some banks may also charge a fee.

Unconnected to the base rate changes, we have also seen a reduction in home loan interest rates in recent times. At present, SBI offers the best home loan interest at 10.15 per cent among the large lenders.

Banks offer the benefits of such reduction in home loan rates only to new borrowers. But with the abolition of prepayment charge on floating rate loans, you have an option to switch to a new lender, offering a lower rate or convert within the same bank to a lower interest rate scheme. However, the decision has to be made after a cost benefit analysis.

The math

When switching between different banks, you will need to consider other expenses such as processing fee (0.5 to 1 per cent). Besides, while pre-payment penalty is done away with for floating rate loans, in case of fixed rate loan, a 2 per cent pre-closure penalty is charged by most banks. In case of conversion within the same bank, the charges vary from 0.5-2 per cent (higher for conversion from fixed to floating rate) on the outstanding loan amount.

The interest savings on both options in turn will be determined by the loan outstanding, remaining tenure, and interest differential. Considering the costs involved, your switch will need to yield substantial savings to cover your costs in both cases.

Suppose your loan outstanding is Rs 50 lakh at 11 per cent and remaining tenure is 15 years. Now consider SBI’s current home loan interest at 10.15 per cent. Is it wise to switch? SBI has capped its processing fee at Rs 1,000 in case of takeover loans (switching from other banks).

The interest savings amounts to Rs 4,75,171 over the tenure of the loan which is sizeable enough to consider a switch here.

For most fixed rate loans over 13 per cent, it would make sense to switch to a floating rate loan at current rates, despite a prepayment charge.

While RBI’s stance on interest rates has left everyone guessing, it would be wise to do your homework now.

> radhika.merwin@thehindu.co.in

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Published on January 05, 2013
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