One does not have to be a finance genius to figure this one out. Most rational people will refinance their more expensive home loan to something cheaper as long as it makes economic sense to do so. But often, there might be some non-obvious costs that might make it expensive to refinance. In today’s falling interest rate scenario, it makes sense to go through some of the basics of refinancing or balance transfer, as it is commonly known within the industry.
When you do a balance transfer, you are transferring your outstanding home loan balance from one lender to another. Under this, the new lender gives your old lender the money outstanding on your loan. Your liability and obligation towards repaying the outstanding amount is now towards the new lender.
The two most common reasons for a balance transfer are to lower your interest payments to the lender or to change the terms of your loan so as to extend its tenure. You can use refinancing as an opportunity to get a top-up loan equivalent to the amount already repaid and on the increased value of your home.
Is there a cost involved?
Contrary to your incentive to save money through refinancing, your existing lender has no incentive to transfer the loan to another bank. So this lender will create some hurdles for you by requiring you to continue with the loan for a minimum period. Check with your lender if you have met this hurdle or not.
Additionally, the existing lender might charge you a penalty fee which could be anywhere between 2% and 4% of the outstanding principal amount of the loan at the time of refinancing.
Finally, the new lender that you are going to go to might charge you a loan processing fee (plus service tax) anywhere between a minimum of Rs5,000 to a maximum of 1% of the loan amount (depending upon whether you are self-employed or an employee).
Does a balance transfer option make sense?
The refinancing needs to make economic sense for you after you have paid the prepayment penalty to your existing lender and the loan processing fee to your new lender. If net of these expenses you will not end up saving any money despite the lower interest rate, then it is pointless to refinance. In fact, it could just be a big administrative hassle to go through a balance transfer.
Who is eligible and what are the tax benefits?
Balance transfers are available to both salaried and self-employed persons. However, there are restrictions on the minimum and maximum age, as well as minimum income criteria. These might vary according to lender, so do your research to see which lender suits you the most.
As far as taxes are concerned, you can get the same benefits as you did under your previous home loan. First, you can continue to avail of the annual Rs1 lakh deduction under section 80C towards the repayment of the principal amount of your loan. Second, you can get up to Rs1.5 lakh annual deduction under section 24 towards payment of interest on the loan.
Three tips to keep in mind
1. Calculate whether it still makes economic sense to refinance, despite the lower interest rate, net of the fees and charges you might be forced to pay.
2. Confirm with the new lender that the low rate is not a teaser rate that will be contractually raised after, say, six months or some other predetermined minimum period. Read the fine print carefully.
3. Ensure that your paperwork is in order for the new lender, especially the property ownership papers, otherwise the disbursement can be delayed.
Kartik Varma and Dhruv Agarwala graduated from Harvard Business School and are co-founders of the New Delhi-based iTrust Financial Advisors.
Content provided by iTrust Financial Advisors
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