I am a co- borrower and a co-owner of a property along with my wife and am repaying the entire loan from my salary account. The details of my home loan from a bank are as follows:
1. Total amount sanctioned: Rs 28.52 lakh.
2. Outstanding: Rs24,41,775.
3. Present rate of interest as per base rate: 9.3%
4. Tenure: 240 months
5. Present equated monthly instalment (EMI): Rs29,800.
My home loan was sanctioned in May 2015, when it was linked to the base rate. From the initial rate of 9.9%, the rates have fallen to 9.3% as on 1 January 2017. My bank is now advising me to enter into a separate agreement to link my home loan to marginal cost of funds based lending rate (MCLR) after paying a fee of around Rs14,000 (0.58% of the outstanding amount). They have also said that if the loan is linked to MCLR now (which will automatically reset the interest rate to 8.6%), any further reduction in the near future will be applicable only after 12 months. I am totally confused. The banks do not have the time to advise customers like me with a detailed breakup. I am also worried whether there will really be any further fall in interest. Please guide me whether it is prudent to make such a move after analysing my loan data.
The concerns being faced by you are valid and true as most of the home loan borrowers, at some point of their loan cycle, grapple with their interest rates.
Let’s understand the facts on how a bank fixes its interest rates. At the time of your borrowing, i.e., in 2015, the banks were using the base rate mechanism to determine the interest rates. Base rate is the minimum rate fixed by all banks, below which the bank cannot charge its customers.
Base rate can be different for different banks. Why is that so? The answer lies in how a bank manages its profit and loss (P/L). So, its profitability based on predetermined factors plays a crucial role in determining its base rate. Typically, a bank reviews its base rate every quarter.
And just to bring in more clarity, base rate was introduced in 2010. Prior to the base rate, the interest rates were fixed based on prime lending rate (PLR). In the PLR regime, banks had the option to give a rate lower than PLR, based on their due diligence of the borrower and wherever the banks believed that it was a low-risk loan. Base rate, hence, was introduced as it aimed to offer more transparency and helped the consumers in comparing the base rates between all banks—all banks were required to disclose their base rates.
However, there was a practical flaw. Whenever the Reserve Bank of India (RBI) reduced the benchmark rates (such as repo rates), the banks were not very responsive in passing the benefit to the consumers. And wherever they did pass it, either it was not the complete pass-back or there was much time delay, thereby defeating the essence of what the RBI expected of banks.
Thus, to further streamline and improve the process, the base rate regime was moved to MCLR from April 2016. This process is expected to speed up the process of resetting the interest rates on a more actual and real time basis.
MCLR also comes with an interest reset option, which means that the interest rate has to be reset at least once a year. So the interest rate, once on MCLR, becomes fixed till the next reset date. This reset varies from one bank to another, and some banks even offer a 6 months reset clause. This means the rate of interest (RoI) can be fixed for the said period. Hence this can be a good option when the interest rates have gone down.
The banks are now giving an option to convert the loans from base rate to MCLR on mutually acceptable terms. While this is not a new loan, and is a mere transfer from one regime to another, banks do charge for this shift.
Typically, the rate of conversion is 0.5% and if they add the service tax and the actual costs to the borrower, the cost does come to about 0.58%.
And this is the rate that your bank is also charging you to convert to an MCLR, along with an interest reset clause of 1 year.
Let’s now check the numbers to determine whether you should be going for the switch.
The loan amount of Rs28.52 lakh at 9.9% RoI for a 20-year tenure with an EMI of Rs27,334. Your outstanding amount reflects that some prepayment has been done.
So, at the current outstanding of Rs24,41,775, at 9.3% RoI for an 18.5 year tenor (reduced 1.5 years of the tenure), the EMI is Rs23,082.
And if we convert to MCLR with everything else remaining same—outstanding loan of Rs24.41 lakh and tenor of 18.5 years, but with an RoI of 8.6%, the EMI becomes Rs22,009. This shows a clear saving of Rs1,073 per month. This means, assuming no further changes in interest rates, the cost of converting to a lower rate gets adjusted in the next 13 months. In a different way, this change of interest by 0.7% can reduce your tenure/EMI period by 2 years.
It is recommended that you convert from the base rate to MCLR, as it aims to be more real time, as well as better regulated. And yes in the current times, there are expectations that the interest rates will be coming down, which makes the case stronger.
Surya Bhatia is managing partner, Asset Managers.
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