If you are an existing home loan borrower, in all likelihood, you are finding yourself saddled with increased equated monthly instalments (EMIs) or with a longer loan tenor. With the Reserve Bank of India (RBI) hiking key policy rates 10 times in the last 15 months, lending rates have gone up by up to 2%.
So what do you do if your budget is not being able to accommodate the higher EMIs? We ran numbers and found out a way out for you: switch your loan to a lender offering a cheaper rate.
What happens in a switch
Here the new bank you have approached pays the older bank the due amount and takes over the loan and you become the new bank’s borrower.
While you get transferred to a lower-cost loan, you have to bear a cost. The older bank will charge a prepayment penalty; you will also have to pay file charges for applying for a fresh loan in the new bank.
Does it make sense?
The good news is if the new lender is offering a loan at a rate cheaper by just 0.5% and even if the processing fee is as high as 3%, you stand to gain on a loan of Rs 50 lakh. Here we factor in a prepayment penalty of 2%.
Interest rate: This should be the basis of your decision. The lower the interest rate, the more substantial will be your saving. Says Adhil Shetty, CEO, Bankbazaar.com, “If you contemplate a switch, make sure it’s at least 1-1.5% lower, which could make a difference to your total interest outgo.”
For instance, if you had taken a loan of Rs 50 lakh a year ago at 11% for 15 years, switching for the rest of the term (14 years) to another lender giving 10.50% will make sense for you even with a 2% prepayment penalty and 1% processing fee. You will end up saving Rs 1.04 lakh in total interest outgo (see graph). Decrease the rate of interest to 10% at the same prepayment penalty and processing fee and your saving will go up to Rs 2.46 lakh.
Cost: You definitely can’t overlook the costs when switching a loan because you need to pay a charge to both banks in the form of prepayment penalty and processing fee. The prepayment penalty is usually in the range of 2-4% of the current outstanding loan amount, while the processing fee is in the range of 0.5-1% of the loan amount.
Says Vipul Patel, director, Home Loan Advisors, an independent mortgage advisory firm, “The total cost of switching the loan is the most important parameter. You should take into account prepayment fees on the existing loan as well as processing fee to be paid to the new lender.”
In the example mentioned above, for the same loan amount and prepayment penalty, tenor of 14 years and interest of 10.50%, increase the processing fee to 4% and the new loan will become costlier by Rs 41,519.
Time: Another important parameter is deciding when to switch. Says Suresh Sadagopan, Mumbai-based certified financial planner, “In the initial years of the loan, you pay more towards the interest component, while towards the end of the loan, the money goes toward the principal part. It’s better if the switch is done in the initial years.”
For instance, on a Rs 50 lakh loan at 10% rate of interest over a tenor of 15 years, your EMI would be Rs 53,730. The interest component of the EMI in the first three years would be in the range of Rs 41,667 to Rs 37,601, but in the last three years, the interest part of the same EMI would be in the range of Rs 14,206 to just Rs 444.
Of course, switching will need your time and effort—from figuring out whether it works for you, gathering your documents once again, cancelling the post-dated cheques given to the earlier bank to signing new ones for the new lender. Online calculators can help calculate your cost and even prompt you if switching works for you. But if you want to contain costs, get going now.
Graphic by Paras Jain/Mint