New home loan takers are being courted with plenty of new deals, but what if you took your loan earlier? If you opted for a home loan product with a much higher interest rate, you can rectify it now. You can move over to a cheaper home loan, of course.
But do a cost-benefit analysis first. There are two ways of making the switch and reducing your EMI. One option is to ask the same bank to shift you to a lower rate. The other option is to switch to a new lender offering a lower rate. Let us look at the costs and benefits under both scenarios.
If you want to move from a pure fixed rate loan to a floating rate loan, then the charges are usually in the range of 1.75-2 per cent on the loan amount.
For instance, ICICI Bank charges 1.75 per cent (on the principal outstanding) in case of conversion from pure fixed loan to floating rate loan, while Axis Bank charges 2 per cent of the loan amount. HDFC also charges 1.75 per cent upfront conversion fee, when switching from a TruFixed home loan product to floating rate home loans.
But the conversion charges are a lot less if you want to switch from a higher floating rate to a lower floating rate loan. Here the charges are around 0.5 per cent in most cases.
If you are looking to switch from one bank to another, in case of floating rate schemes, pre-payment charges have long been done away with. But banks charge a pre-payment penalty in the case of fixed home loans.
In most cases, the penalty is around 2 per cent on the loan outstanding.
Once you have foreclosed your loan, you then approach a new bank for a fresh loan. Here, banks charge a processing fee, which ranges from 0.5 to 1 per cent of the loan. There could be an additional service charge too.
But look for waivers offered by a few banks. SBI offers a concessional processing fee of ₹1,000 (valid till August 31, 2014) for loans taken over.
Savings The benefit of switching your loan is clearly the regular saving you make on interest outgo. The amount that you save will depend on the amount of loan outstanding (higher the amount, the more you save), remaining term of the loan (longer the term, higher the savings) and the interest differential (bigger difference means more savings).
Most banks charge 10.25 per cent on floating rate loans. Let us assume that you had taken a ₹60-lakh home loan for 15 years at 10.25 per cent.
If you are looking to switch to the lowest rate i.e. 10.15 per cent, then you get to save just ₹369 on your EMI. While over the entire term of the loan the interest savings may appear sizeable (about ₹66,000), do weigh the costs of switching.
A quick calculation shows that it would be best to make the switch if you can save at least 50 basis points more as interest.
Let us assume that you have taken a home loan at 10.75 per cent, one of the higher rates offered by a few banks.
The lowest rate now offered by SBI and ICICI Bank at 10.15 per cent offers more than a 60 basis point reduction in your interest rate. If you decide to move to one of these schemes, then your EMI will come down by ₹2,229 to ₹65,028; or about ₹4 lakh of interest savings over the entire tenure of the loan.
For such huge savings, go ahead and switch your loans, no matter how rates move from hereon. Even if your bank does reduce its rates by 25 basis points in the coming year, you still get to save about ₹2.3 lakh over the tenure of your loan. However, in case of switching from a fixed rate loan to a floating rate one, remember there is an additional prepayment charge of 2 per cent which may shrink the benefit.
So, before you switch your loan, make sure that your savings are worth all the effort. Interest rates may, in any case, start to come off in the next two years and unless you are paying a very hefty premium for your current home loan it may be best to stay put for now.
Ask for lower tenure; pay off your loan sooner
When rates do start to decline, don’t just look for monthly savings on your interest outgo, rather look at lowering the tenure of your loan. When rates change, banks, by default, alter the tenure of the loan and not the EMI. This works well in a declining rate scenario.
Let us assume that you had taken a floating rate home loan for ₹60 lakh at 10.75 per cent for a tenure of 15 years. The EMI for this loan would work out to ₹67,257. If your bank were to lower the rates to 10.5 per cent, your EMI would reduce to ₹66,324 and interest over the tenure of the loan would go down by a total of ₹1,67,929.
But as banks alter the tenure instead, in this case, the term of the loan would go down by six months, but thanks to the wonders of compounding, your total interest outgo over the tenure of the loan would have declined by about ₹4 lakh, even if your EMI remains constant. Thus, as a ground rule, if interest rates go up, ask for an increase in EMI; when rates decline, though, it pays to reduce the tenure of your loan as then your total interest outgo will be much less.