How to decide about refinancing an MCLR home loan – An in-depth analysis

By: |
September 22, 2020 12:17 PM

Even the MCLR home loans have seen interest rate cuts, but the revisions haven’t been as deep and quick as their repo-linked counterparts.

We have come up with an in-depth analysis of a typical scenario and have also shared a few smart tips to maximise the refinancing benefits.

If you’ve been servicing a Marginal Cost of Lending Rate (MCLR) home loan, the question of refinancing it to a repo-linked loan could be on top of your mind for a while now. Ever since the RBI directed banks to link their loans to an external benchmark in October last for swifter transmission of rate cut benefits, most of the banks have introduced a repo-linked loan regime. And since the central bank has reduced the repo rate by 250 basis points since the beginning of 2019, these repo-liked home loans have seen record-low interest rates (some banks are currently offering loans starting at under 7%). Even the MCLR loans have seen interest rate cuts, but the revisions haven’t been as deep and quick as their repo-linked counterparts.

So, should you go for a re-financing now? You should make an informed decision after carefully factoring in a number of critical considerations like your loan amount, the difference between the interest rates, remaining loan tenure, your credit score, loan transferring charges among other things. To help you with this, we have come up with an in-depth analysis of a typical scenario and have also shared a few smart tips to maximise the refinancing benefits. Let’s take a look.

Case study: A borrower with an MCLR home loan of Rs 1 crore taken in 2016

Let’s suppose Amit took a home loan from a bank in July 2016. The MCLR-linked loan is of Rs 1 crore for 20 years at 9.45%. As of July 2020, his loan balance is approximately Rs 89.52 lakh. His recent annual reset has taken his rate to 7.85%. He has three options now. One: refinance the loan with his bank for a better interest rate. Two: make a balance transfer to a new lender offering a rate lower than his bank. Three: do nothing. What should he do?

Let’s look at Amit’s loan repayment thus far, and the road ahead following the latest rate reset to 7.85%.


After 48 EMIs, Amit had repaid only Rs 10.47 lakh of his principal while the rest — about Rs 34 lakh — was interest. His original projected interest was Rs 1.22 crore. However, recent loan rate cuts have reduced Amit’s projected interest. Without the cuts, he would have had to pay around Rs 88 lakh more. After the recent cut, he needs to pay only Rs 52.30 lakh more. Therefore, Amit has saved nearly Rs 36 lakh without having to take any steps such as refinancing. So is doing nothing his best option? To know this, we need to calculate the benefits of refinancing.

To refinance or not to refinance?

Amit’s loan has an MCLR-linked rate of 7.85%. His bank is now offering a repo-linked loan at 7.40%, 55 basis points lower than his MCLR-linked rate. The difference is significant. Refinancing, therefore, could save Amit much more. Let’s look at the math.

Option #1 vs. Option #2

Option #1: Convert his loan to a repo-linked scheme with an interest rate of 7.40%. To avail the scheme, Amit must pay a conversion charge of Rs 5000. Amit had also applied to another bank, which has given him an offer of 7.00% for a balance transfer to a repo-linked loan. The fees are Rs 35,000. Let’s compare the outcomes of either option in the table below.

Option #2 helps Amit save more

Amit decided to refinance his loan through a balance transfer to a new bank. His justification is simple: it saves him a lot more money over the full loan tenure.

Switch hit: Retain your old EMI

Amit chose to refinance his loan with a new bank. However, instead of opting for a lower EMI of Rs 88,098, he decides to keep paying a higher EMI. He voluntarily rounds off his new EMI to Rs 100,000. This will accelerate his loan repayment, save him an additional Rs 8.90 lakh and help him close his loan in 126 months instead of 153, as demonstrated in the table below.


Conclusion

Amit transfers his loan to a new lender offering a rate 85 basis points lower than his current rate. He follows the Switch Hit plan and increases his EMI to Rs 1 lakh voluntarily. This allows him to close his loan 14-15 years instead of 20. His remaining interest falls to Rs 36.89 lakh from the earlier Rs 52.30 lakh. He would therefore save Rs 15.41 lakh on interest if he decides to refinance – a more profitable option than doing nothing. It could take Rs. 68,000 annual investment in PPF for 13 years (at 7.1% p.a.) or a Rs 4100 SIP in a 12% growth equity fund to build a fund of Rs 15.41 lakh.

A few key pointers to consider before finalizing your refinancing move:

The difference in interest rates: Consider refinancing your loan only if there’s a substantial difference between the interest rates.

Credit score: Repo-linked loans usually consist of a customer risk spread. If your credit score is below 750, you might not be eligible for the best-offered rate. Additionally, you need to maintain a good credit score throughout the tenure of your loan to keep enjoying the lowest possible rates.

Remaining loan tenure: Refinancing your MCLR loan towards the end of your loan tenure might not lead to substantial savings in interest payments.

Cost of refinancing and ease of transfer: Always consider refinancing costs like processing fee and loan transfer charges in your calculations. Also factor in the ease of transfer in terms of additional paperwork among other formalities.

Prepayment: Regardless of your loan regime, always try to make adequate prepayments when the applicable interest rate is low to reduce your loan burden and become debt-free faster.

(The author is CEO, BankBazaar.com)

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