Following rate cuts by banks, the country’s leading mortgage lender, HDFC, has reduced its home loan rate by 20 basis points (bps; one bps is one-hundredth of a percentage point) to 9.9%. Matching its competitor, State Bank of India cut interest rates on new home loans by 25 bps. Similarly, ICICI Bank is now offering 9.9-10%.
So, if a new borrower takes a R50-lakh loan for 20 years at 9.9% per annum, the equated monthly instalment (EMI) will be R47,920. Earlier, at 10.1%, the EMI would have been R48,583. This means a saving of R663 per month. Over the 20-year period, the borrower can save as much as R1,59,000 provided the interest rate remains the same. Before the rate cut, HDFC gave home loans at 10.1% while SBI charged 10.15%. After the cut, the state-owned bank is offering loans to women at 9.85% and to others at 9.9%. Besides, an immediate benefit of the rate cut is that for a new borrower, the loan eligibility amount will increase.
Borrowers benefit from a fall in rates, especially so in case of floating rate home loans. For an existing borrower, in case of a rate cut, the lender either keeps the EMI unchanged and reduces the loan term, or reduces the EMI and increases the loan tenure. It makes sense to either keep the EMI unchanged or, if possible, even increase it so that the interest outgo is reduced significantly. Analysts say that when interest rates drop, the borrower should increase the EMI and accelerate repayment of the outstanding principal.
To cite an instance, for someone who has borrowed R50 lakh and paid for five years out of the total tenure of 20 years, a 20-bps cut will reduce the EMI by R550, from R48,583 to R48,033. This would mean total savings of R99,000 in interest payment for the remaining tenure. On the other hand, if the borrower keeps the EMI unchanged and reduces the loan period by 4 months, the net savings on interest would be over R2 lakh, provided the interest remains the same for the entire loan period.
Ideally, one’s EMIs should not exceed 40-50% of one’s monthly income. If the EMI is much lower, increasing the EMI is an effective way to ensure the loan is repaid early. An EMI hike can be requested at any point during the loan period and, usually, there are no charges for it.
Should you switch?
If your lender is charging a higher rate, it makes sense to switch. But before you do that, ensure that the difference between the interest rate of the two lenders is at least 75-100 bps. One has to pay charges such as processing (around 0.25% of loan due) and legal fees to switch to a new lender.
Experts say one should switch only if more than seven years of repayment remain. Anything lower than that, and the cost of refinancing will nullify all the gains. They also say it’s not always wise to switch just for a better rate. One must calculate the actual amount one can save, after adjusting all the charges. Besides, it could be a dampener if a borrower switches and the new lender also hikes the rate after a few months.
Loans from housing finance companies (HFC) are linked to the prime lending rate (PLR). Prior to July 2010, banks and HFCs used to link the interest rate with their benchmark PLR, which was fixed by each lender on its own. There was no transparency on how the PLR was fixed.
Hence, even today, existing borrowers who availed loans prior to July 2010 pay higher interest rates. The Reserve Bank of India had instructed banks to shift from July 2010 to the base rate — the minimum rate that a bank is allowed to charge its borrowers.
Borrowers can opt to make partial payments at regular intervals, say, every six months or a year to repay quickly and save on interest. Banks and HFCs do not charge any pre-payment penalty for principal repayment. So, there are lots of options available to the borrower, but proper assessment is required before going in for one.
* In case of a rate cut, either keep the EMI unchanged or, if possible, even increase it so that the interest outgo comes down
* If your lender is charging a higher rate, it makes sense to switch to another lender. But ensure that the difference between the two interest rates is at least 75-100 bps
* switch only if more than seven years of repayment remain. Anything lower than that, and the cost of refinancing will nullify all the gains from the lower rate
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