Right time to switch to a new home loan? - Livemint

In the past seven days, at least nine financial institutions have cut their minimum lending rate by 15-25 basis points (bps). One basis point is one-hundredth of a percentage point. State Bank of India (SBI), HDFC Bank Ltd and Kotak Mahindra Bank Ltd cut their base rate by 15 bps to 9.85% from 10%. Axis Bank Ltd reduced its base rate by 20 bps to 9.95%. ICICI Bank Ltd cut its base rate by 25 bps to 9.75% from 10%. Non-banking finance companies including Housing Development Finance Corp. Ltd (HDFC), Dewan Housing Finance Corp. Ltd and Indiabulls Housing Finance Ltd have reduced home loan rates.

All these changes may lead home loan borrowers to think if it's time to reassess the loan. Is this an opportunity to switch to a lower rate home loan?

Know the lender's offers

A base rate cut doesn't always give the same benefit to an existing borrower as it does for the new borrower. Let's take a look at the SBI home loan rate change. "New customers will get home loan at 9.85% and 9.90% whereas an existing customer's home loan rates will drop to 9.95-10% from 10.10-10.15%," said J. Lakshmi, chief general manager-real estate, habitat and housing development, SBI. Earlier, SBI used to offer home loans at 10 bps above the base rate for women and 15 bps above base rate for others. However, now it is giving home loans to women at base rate and to others at 5 bps above the base rate.

There also may be instances where though your bank has cut rates, you still continue to pay a higher rate of interest. In such a scenario, you can consider switching lenders. There are some financial institutions that have not reduced their interest rates on home loans.

A calculated decision

The decision to switch or not to switch a home loan is a calculated decision as interest rate is not the only factor to consider. For instance, if your current loan is at 10.2% and another bank's offer is of 10%, here's how to calculate the real cost of switching.

Step 1: Compare the lower interest rate of the home loan product where you want to switch to with your existing home loan rate. For instance, the monthly instalments on a home loan of Rs.40 lakh with an interest rate of 10.20% per annum and a tenor of 20 years will drop by about Rs.530 per month if the new loan is available at 10%. The total interest payout will be lower by around Rs.1.27 lakh.

Step 2: This is a repeat of Step 1, but with the remaining term of the outstanding loan. Let's assume you took a loan in April 2010. This means that the remaining tenor of the loan is 15 years. The outstanding loan balance will be around Rs.36 lakh. If you switch the loan to a lender that offers 10% interest rate, your EMI will reduce by around Rs.440, which means a saving of about Rs.79,400 on the total interest cost.

If the same loan had 5 years remaining, the outstanding balance would be Rs.18.33 lakh. Moving to a loan of 10% rate will mean the EMI coming down by around Rs.180, and total interest cost saving of about Rs.10,700.

Step 3: Switching your home loan comes with a cost. So, include this in the calculation. "Besides the interest rate on a home loan, you will have to check the foreclosure charge of your existing bank and the processing fee of the new bank," said Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd.

There is no prepayment charge on floating rate loans, but some fixed rate loans may have it. The processing fee on the new loan can vary from 0.25% to about 1% of the total outstanding loan amount, or it can be a flat fee. Some banks also levy administrative charges. "Besides the processing charges, which are usually capped at Rs.10,000, there will be some nominal expenses towards vetting of the property," said Lakshmi.

In the example that we used in Step 2, if 15 years remain on the loan, and the bank asks for Rs.10,000 as processing charge, your total savings gets reduced to Rs.69,400. If the processing fee is, say, 1%, your savings get reduced to about Rs.42,000. This means that if the processing fee and other changes add up to be higher than the total interest cost you would save, it doesn't make sense to switch the loan.

Step 4: Remember that switching a home loan is almost the same as taking a new loan in terms of documentation. "Usually, there are two ways to switch a home loan. You can either approach the bank as a new customer, which means you have to submit all your property documents, or, depending on the bank, you may get a waiver on credit evaluation," said Jairam Sridharan, president—retail lending and payments, Axis Bank. The waive off is applicable for select bank home loan borrowers. Most lenders take five days to four weeks to clear a loan application.

What should you do?

With reduced rates you can expect either your EMI or the tenor of the loan to come down. "For instance, for a Rs.25-lakh loan of 20 years, if the interest rate goes from 11% to 10.8%, the EMI will reduce by about Rs.400 or the tenor will go down by 11 months," said Sridharan.

The effect and timing of a change in loan rates can differ across lenders, and hence you may not see an immediate impact on a loan. For instance, HDFC implements changes on a quarterly basis, while SBI does it from the same day.

If you are not satisfied with the new rates that your lender is offering, you can switch to another bank or housing finance company that gives a lower rate. If you find it difficult to calculate the cost of switching, make use of online EMI calculators.

Generally, if you have a long tenor remaining, switching is likely to be more lucrative than if the end of the tenor is approaching. "Switching is equivalent to taking a new loan. You have to be willing to go through the tedious paperwork to get the benefit of the new rate," said Suresh Sadagopan, a Mumbai-based financial planner. Also, factor in all the charges. Only then will you know if the move is worth it.

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