Amit Shanbaug, ET Bureau Feb 18, 2013, 08.00AM IST
Thirty seven-year-old Sunil Nadkarni is facing a dilemma common to many a home loan borrower. He is wondering whether to prepay and save interest on the home loan or keep the money for a rainy day.
The urge to prepay at least a part of the principal is strong. In 2006, the Mumbai-based banking executive was paying an EMI of Rs 6,134 at an interest rate of 7.5%.
With the rate jumping to 12%, Nadkarni’s monthly mortgage payment has shot up to Rs 8,400, and his loan tenure is now 45 years from the initial 25.
At the same time, he is worried about the liquidity crunch he might face should any contingencies crop up soon after deploying his funds. Perhaps he doesn’t really have to make a choice. For all those wanting to have their cake and eat it too, banks offer a product called home saver loan.
What’s a home saver loan?
This facility allows the borrower to deposit his excess savings in a current account linked to his home loan account. While calculating the interest component, the bank deducts the balance in the current account from the borrower’s outstanding principal.
Typically, the average monthly balance in the account is considered for this purpose. Meanwhile, the money can be easily withdrawn in case of an emergency. The only drawback is that banks charge about 0.5-1% more than the rate on regular home loans. At present, this facility is being offered by leading players like the IDBI Bank, Citibank, SBI, Standard Chartered Bank and HSBC.
How does it work?
Assume that you need a home loan of Rs 25 lakh. At an interest rate of 10.5% for a 20-year tenure, the EMI for the plain vanilla home loan works out to Rs 24,959.
In the first month, the interest portion is Rs 21,875, while the balance, Rs 3,084, goes towards principal repayment, leaving Rs 24.96 lakh as the outstanding loan.
The second month’s interest will be calculated on this amount, and so on for the next 238 months.
On the other hand, if you were to opt for a home saver loan, the higher interest rate of 11% would initially translate to an EMI of Rs 25,805.
Now, suppose you receive Rs 5 lakh as your annual bonus, which you deposit in the linked current account.
In this case, your interest obligation would be calculated on just Rs 20 lakh. Not only does your loan tenure come down to 136 months (a little over eight-and-a-half years), you also save Rs 19.69 lakh on interest (see table).
What are the benefits?
The money in the linked current account not only helps reduce your interest burden, while remaining easily accessible, but is also safe from the taxman. Moreover, though this balance is treated as part payment, the bank does not impose any prepayment penalty for the same. Even if you do not foresee a windfall coming your way, you can choose to avail of this product by simply depositing a recurring amount in your current account, say, a part of your salary, and watch the power of compounding work its magic.
Who can make the most of it?
According to Pankaaj Maalde, head, financial planning, at ApnaPaisa.com, the financial services portal, the home saver loan suits everybody. Since it is advisable to maintain nearly six months’ worth of household expenses as a contingencies corpus, people can park this amount in the linked current account and acquire dual benefit. “The contingency fund could range from Rs 3-10 lakh, especially in households with dependent parents. We also include medical contingencies in this kitty,” says Maalde. Imagine the amount you could shave off your outstanding principal with this corpus parked in a current account linked to a home saver loan account.
What are the disadvantages?
As mentioned earlier, home saver loans are more expensive than regular home loans. Secondly, the deposit in the current account doesn’t generate any interest income. If you were to invest this money in mutual funds or equity, you’d earn much higher returns. So, this option is primarily for those for whom liquidity is a concern. As with any financial product, the rule of thumb is to shop carefully for the best deal since interest rates differ from bank to bank.
But be aware that the eligibility criteria will also vary. For instance, Citibank Home Credit requires a salaried individual to have a minimum gross annual income of Rs 1 lakh and at least two years of work experience to be eligible for this product. However, for Standard Chartered’s home saver loan, the threshold is Rs 2.76 lakh per annum. According to VN Kulkarni, chief counsellor at Abhay Credit Counseling Centre, a borrower must take the time to understand the math for home saver loans and the various charges involved before rushing to buy this product. “Some calculations might be a bit confusing, so don’t be hasty,” he cautions.
Source : http://goo.gl/EbaJ7