All of us who are servicing a home loan share a common aim — to save on interest by making prepayments. Taking cognizance of this, banks, too, are devising plans to assist borrowers. One such scheme is offset loan or home loan overdraft, also popularly known as the smart home loan scheme.

So, if you plan to take a home loan and are looking for a smart deal that saves on interest repayments in the long run, you can consider an offset loan. Many lenders, including State Bank of India, Citibank, PNB and HSBC, offer this scheme.

Smart home loan is a facility offered by banks that allows customers to offset the interest earned on the money deposited in the bank in a specific loan account against interest on home loan. Under this scheme, the borrower has to maintain a loan account, which is like a current account with an overdraft limit equal to the amount of the sanctioned loan. The borrower can deposit surplus money in this account, withdraw at any time and even manage EMIs with this amount. Banks offer a passbook and a debit card for this account.

Interest calculation

Usually, the interest on offset loans is 0.1-0.5% higher than on plain-vanilla loans. The borrower can use this facility only if he maintains deposits over and above the bank’s specified threshold limit. The interest on the loan is then calculated after subtracting any additional savings maintained in the account every month (over the EMI) from the outstanding loan.

For example, if the EMI is Rs 35,000 and a borrower has Rs 50,000 in his account, then Rs 15,000 would be deducted from the outstanding loan. In some cases, the threshold amount to be maintained in the account is specified by the bank. For example, Citibank has a minimum threshold of Rs 1 lakh.

Lower interest, shorter tenure

Suppose a borrower is servicing a home loan of Rs 50 lakh and has maintained a deposit of Rs 1 lakh after six months.

The interest is then calculated on Rs 49 lakh. If he maintains this deposit in the loan account throughout the tenure of the loan, the overall interest paid towards the loan comes down significantly, and so does the tenure.

Suppose that Rs 50 lakh has been borrowed under a smart home loan, at 10.50% for 20 years, and the borrower maintains Rs 1 lakh over and above the threshold limit in his loan account for 20 years. He is thus repaying his home loan in 227 months, instead of 240. He pays Rs 63.2 lakh as total interest during the tenure of the loan.

If he takes Rs 50 lakh as a regular home loan at 10% for 20 years, he repays the loan in 240 months and pays Rs 65.8 lakh as interest during the tenure of the loan.

Clearly, by going in for a smart home loan, he has saved almost Rs 2.6 lakh in interest payment.

If the interest rate differential is reduced, interest savings go up. In the above example, if the rate of interest is 10.2%, the tenure under the smart loan option comes to 228 months, and the total interest paid during the tenure is Rs 61.2 lakh, saving around Rs 4.6 lakh compared to the regular option. However, if the interest differential between a regular home loan and a smart home loan is more than 0.50 percentage points, the benefit of a smart home loan vanishes.

Opportunity cost

There is an opportunity cost involved in the arrangement under the smart home loan. Here, you are keeping an additional sum in the loan account to offset the interest cost on the home loan. Before committing yourself to such an option, always calculate the opportunity cost of keeping an amount locked in the loan account. In the above example, if the borrower had kept the money in a bank fixed deposit fetching 8% interest a year, he would have made Rs 4.6 lakh in 20 years. Therefore, always do a cost-benefit analysis before opting for an offset loan.

What is offset loan scheme?
* Smart home loan or offset loan scheme is a facility offered by banks that allows customers to offset the interest earned on the money deposited in the bank in a specific loan account against interest on home loan
* Under this scheme, the borrower has to maintain a loan account, which is like a current account with an overdraft limit equal to the amount of the sanctioned loan
* The borrower can deposit surplus money in this account, withdraw at any time and even manage EMIs with this amount. Banks offer a passbook and a debit card for this account
* Usually, the interest on offset loans is 0.1-0.5% higher than on plain-vanilla loans
* The borrower can use this facility only if he maintains deposits over and above the bank’s specified threshold limit
* The interest on the loan is then calculated after subtracting any additional savings maintained in the account every month (over the EMI) from the outstanding loan

The writer is CEO of BankBazzar

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