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Home loan rates have started rising. Experts believe interest rates may rise by as much as 200 basis points in two years. As this happens, your home loan tenure and your interest burden will increase. However, small tweaks to your payment plan can ensure your loan doesn’t drag on and you become debt-free on time. 

Here are some things you can do now to make it happen. For illustrative purposes, the sample numbers we’ll use here are as follows—a loan of 50 lakh at 7% for 20 years, where the EMI is 38,765 and the interest is 43.03 lakh.

 Refinancing your  loan

Firstly, understand your loan benchmark. Every loan has one. The benchmark is the lowest rate at which a loan can be given. Most bank loans since October 2019 are linked to the repo rate. Loans from before that time since April 2016 are linked to the MCLR. Before that, it was the base rate. 

Non-banking financial companies (NBFCs) use prime lending rates. Today, repo-linked loans are the cheapest. But only banks provide them. You could refinance your loan from bank to bank, NBFC to bank, or bank to NBFC. The choice is yours. Do a cost-benefit analysis of each option. 

Refinancing happens in two different ways. Firstly, you can ask your own lender to lower your rate. You’ll need to pay a small processing fee — typically, a few thousand rupees. One of two things may happen here. One, you’ll get a lower rate if your loan is with an NBFC but your benchmark is unchanged. Or two, you may get moved to a repo loan with a lower rate, if your loan is with a bank. You can refinance even if the difference between rates is low — say, 25 basis points. Refinancing the above loan to 6.75% for 20 years reduces the interest to 41.24 lakh. This, therefore, cushions you against a rate hike temporarily. 

Secondly, refinancing can also be done by transferring your loan to another lender offering you better terms. This is called a loan balance transfer. It involves more paperwork and has higher costs. You will need to pay processing fees, legal fees, and mortgage registration fees. Typically, these costs are between 0.5% to 1% of the loan. A transfer is sensible when the  difference in rates  is sizeable— say, 50 basis points or more — and when you’re closer to the start of your loan tenure than its end. 

Increasing your EMIs

When you refinance, you may have the benefit of a lower EMI. This sounds useful and leaves you with a higher disposable income. But consider the alternative. You could keep your older, higher EMI. This helps pay off the loan faster. In the above example loan of 50 lakh, your EMI is 38,764 at 7% and 38,108 at 6.75%. If you refinance to 6.75% but pay the original EMI (basically, 656 more per month), it shaves off eight EMIs from the loan and reduces your interest to 39.57 lakh. 

The higher EMIs essentially provide you with micro pre-payments, helping you bypass the requirement that the pre-payment needs to be at least one EMI’s worth. As your disposable income increases with time, you can pay higher EMIs. In the above 6.75% calculation, let’s say you chose to increase your EMI to 50,000. This slashes your loan from 240 months to 148. It also cuts your interest down to 23.68 lakh. This is a powerful option. 

Smart prepayments

A one-time lump-sum prepayment erases the added interest from the rate rise. For example, if your 50 lakh loan for 20 years has a rate hike of 25 basis points to 7.25%, your interest increases to 44.84 lakh. It also adds 11 EMIs to the loan. But an immediate bullet payment of 1 lakh erases the additional EMIs. 

The other option is to prepay systematically. We believe the optimal prepayment for a home loan is 5% of your loan balance once every 12 months. This method helps pay off a 20-year loan in around 12 years assuming a constant rate. This is optimal. You could always go faster if you want to. The idea is to use more of your savings for investing and wealth creation.  A combination of the above options will also help. What you mustn’t do is not act. That would increase your interest substantially. 

In a worst-case scenario, if your 7% loan went to 9% in two years, you could be staring at over 100 additional EMIs. These could become barriers to the fulfillment of aspirations such as retirement or children’s education. You wouldn’t want that. 

Adhil Shetty  is CEO, BankBazaar.com.

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