How to manage your home loan repayments

A home loan is probably the biggest financial commitment most people make. Home loan EMIs last for at least a decade and are the largest monthly expenditure item for a majority. Hence, borrowers usually look out for ways to reduce their home loan interest burden. Here are a few tips on how to manage your home loan interest in the most cost-effective manner.

Switch to MCLR: Both home loan borrowers and Reserve Bank of India have accused banks and other lenders of neglecting existing borrowers while reducing interest rates. To deal with this problem, RBI made the banks to switch over to MCLR (Marginal Cost Based Lending Rate)-based lending rates from April 1, 2016. While all the new bank loans are being lent on MCLR-based rates, existing borrowers till March 31, 2016 have the option of switching over to MCLR.
As the repo rate is used while calculating MCLR, it reflects the changes in the policy rates better than the earlier BPLR and base rate systems. The MCLR regime requires banks to mandatorily review their MCLR every month and reset the interest rates of existing borrowers at least once in a year. Even the interest rate reset date has to be communicated to the borrowers at the time of loan disbursal. The provision of fixed dates for interest rates will force banks to pass on the future repo-rate reduction to the borrowers. These features make MCLR-based rate-setting system much more transparent than previous rate-setting systems. Given the current declining interest rate regime, existing borrowers under the previous rate systems should switch to MCLR to benefit from future rate cuts.

Reset your loan to lower rate: RBI has not included NBFCs and housing finance companies (HFC) under the MCLR system. However, their existing borrowers can reduce their interest rate by paying a conversion fee. This fee can go up to 1% of the outstanding principal.

Make prepayments: Home loan borrowers can prepay the entire or a part of the outstanding home loan amount. Although, the lenders cannot charge prepayment penalties on floating rate homes loans, they charge up to 2% of the outstanding fixed rate home loan amount as prepayment penalty. Thus, make sure that your savings in interest cost is higher than the prepayment penalty. Use the proceeds of financial windfall like your annual bonus or a maturity of an investment plan to prepay a part of your outstanding balance. However, do not use your emergency fund or investments generating higher rate returns than your interest rate on home loans. Investments in equity funds or equity ULIPs can easily generate higher returns over the long term (above 5 years) than what most home loans currently charge. Instead, close your surplus bank or post office fixed deposits and other fixed income securities, which generate lower rate of returns than the interest rate charged on your home loan.

Increase your EMI: Your monthly income plays a major role while setting your EMIs. Generally, lenders prefer your EMIs to stay within 40% of your monthly income. You can make considerable savings in interest cost by diverting a part of your income increments for higher EMIs. However, while doing so, do not reduce your contribution to long term investment goals.

Opt for home loan balance transfer: Under this option, you can transfer your entire outstanding home loan balance to another lender at a lower interest rate and other better terms and conditions. Go for home loan balance transfer if your existing lender refuses to reduce your interest rate. Existing borrowers from NBFCs and HFCs can use this option to transfer their home loan to banks and benefit from MCLR-based interest rates.

by Ajay Mishra - Vice President & Business Head- Secured loans, Paisabazaar.com