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  1. Lending rates going south: What should existing home-loan borrowers do?

Lending rates going south: What should existing home-loan borrowers do?

Flush with funds, banks and HFCs have started reducing their lending rates significantly, which is good news for the prospective home-loan borrowers.

By: | Published: January 3, 2017 1:12 PM
The other option to save money on your home loan will be to prepay the home loan when you accumulate some funds from own sources. (Reuters) The other option to save money on your home loan will be to prepay the home loan when you accumulate some funds from own sources. (Reuters)

Flush with funds, banks and HFCs have started reducing their lending rates significantly, which is good news for the prospective home-loan borrowers. However, in a falling interest rate scenario, most existing home-loan borrowers also get tempted to shift to the lender with lower rates, particularly in cases where the existing lender remains reluctant to pass on the benefit of rate cuts to their existing customers. But it is also a fact that the transfer of home loan from one lender to another bears some charges.

First, “the bank, from where you are transferring home loan balance, will deduct prepayment charges, which can be around 2%-4% of the principal outstanding. So, the decision of shifting will greatly depend upon the transfer cost in the case of fixed rate loans. But floating rate home loans do not attract any fee. So, if you are in a floating rate regime and see a lender offering you home loan at a much lower rate than the existing one, it is advisable for you shift to that particular lender,” says Rishi Mehra, co-founder, deal4loans.com.

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For example, suppose you are servicing a 20-year floating rate home loan of Rs. 30 lakh with a lender at an interest rate of 9.65%-9.70% p.a. Two years have gone by since you had taken the loan. Now you want to shift the entire loan balance of around Rs. 28.90 lakh to SBI at an interest rate of 8.50%-8.65% p.a. for 18 years. Well, the move, if comes into effect, will lead to considerable savings over a period of time, which is explained below:

Loan Amount Tenure Interest Rate EMI Total Interest
Rs. 28,90,000 (SBI) 18 Years 8.50%-8.65% p.a. Rs. 26,168-26,435 Rs. 27,62,228-28,19,939
Rs. 30,00,000 (Previous Lender) 20 Years 9.65%-9.70% p.a Rs. 28,258-28,357 Rs. 37,82,027-38,05,657
Rs. 30,00,000 (Previous Lender) 2 Years 9.65%-9.70% p.a. Rs. 28,258-28,357 Rs. 5,69,262-5,72,271

Total interest outflow if you transfer your loan balance to SBI over the course of 20 years = Rs. 33,31,490-33,92,210.

(ie. Rs 27,62,228+Rs 5,69,262 and Rs 28,19,939+ Rs 5,72,271)

Thus, savings in interest outflow by transferring home loan to SBI= Rs 4,13,447-4,50,537 (Rs. 38,05,657- 33,92,210, Rs. 37,82,027- 33,31,490)

The other option to save money on your home loan will be to prepay the home loan when you accumulate some funds from own sources, such as the salary hike due to promotion or the generation of savings through investments. Doing this will also reduce your interest.

Adhil Shetty, founder & CEO of BankBazaar.com, says, “In a falling interest rate scenario, you need to calculate two things: the first is the quantum of savings you will generate with your existing lender, and the second is the quantum of savings generated by transferring to another lender.”

If the second option generates greater and significant long-term savings for you, you should consider transferring. However, do factor in the costs of transfer along with the possibility of the new lender increasing his rates at some point in the future.

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“Besides a transfer, also strongly consider the benefits of pre-payments. When interest rates are low, it is when you should aim to heavily make pre-payments. In fact, you should save less in fixed-income instruments and divert more towards home loan principal pre-payments. When interest rates are falling, pre-payments make a greater impact in reducing your outstanding principal. This would help you when the interest rate starts to rise again,” informs Shetty.
Let’s say you have a 20-year home loan for Rs. 30 lakh at an interest rate of 10%. You’ve been paying EMIs since January 2015. Your EMI is Rs. 28,950. After 24 EMIs, in January 2017, in addition to your EMI you pre-pay Rs. 100,000. Assuming no interest rate change, this pre-payment reduces your loan tenor from 240 months to 221 (-19 months), implying savings of approximately Rs. 550,000.

But if the interest rate falls to 8%, and if you make the same pre-payment – Rs. 100,000 in January 2017 – your loan tenor would plummet to around 201 months from the original 240. This is a significant reduction caused by just one pre-payment.

Therefore, you must work with your lender (or use online EMI calculators) to figure out your savings through interest rate reductions, and then decide if you should transfer to another lender.

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