RADHIKA MERWIN | September 14, 2013 | Business Line

If you’ve taken a home loan, get ready to tighten your belt, for interest rates have begun to creep up once again. The base rates of leading banks (which decide lending rates), after falling by 50 basis points between April 2012 and May 2013, have risen by 25 basis points in the past one month.

After the RBI’s liquidity tightening measures in July, short-term borrowing costs for banks have gone up by 1 to 2 per cent. This has resulted in banks raising their lending rates to safeguard their margins. So what should you, the home loan borrower, do? Shop around for the best deal, of course.

Best deal for newbies

But first, let’s get some background. While market interest rates have certainly shot up, it hasn’t affected all banks equally. That’s why more private sector banks than public sector banks have raised their rates in the last month. Four private sector banks have so far raised their base rates. ICICI Bank raised its base rate from 9.75 per cent to 10 per cent. HDFC Bank, which had the lowest rate among all banks, raised its rate by 20 basis points to 9.8 per cent. Axis Bank and Yes Bank have also raised their base rates.

Most public sector banks, however, have held on to lower interest rates for their home loans. Only Union Bank and Andhra Bank have raised their base rates. SBI, which has the largest home loan portfolio among banks, has the lowest base rate of 9.7 per cent and is yet to increase it. As for housing finance companies (HFCs), HDFC increased its retail prime lending rate, on which home loan rates are benchmarked by 25 basis points to 16.65 per cent.

After these tweaks, most banks and HFCs offer floating rate home loans in the range of 10.6-10.75 per cent. If rates are your primary consideration, SBI offers the lowest one at 10.1 per cent for loans above Rs 30 lakh. Therefore, it is SBI you must go to if you want the cheapest home loan. SBI hasn’t hiked its lending rates so far. Even if it does, with the next best rate at 10.65 per cent, SBI’s rates may still remain attractive after the hike.

But it would be good for new borrowers to put off their home loan decision until the RBI’s next monetary policy review due on September 20. This would be critical to decide on the future direction of rates.

If the central bank continues its tight liquidity measures, more banks could be raising rates, including SBI. But if the measures are rolled back, banks may put a stop to further rate hikes and loans from private banks may possibly get cheaper.

Fixed or floating?

But why go in for a floating rate loan at all? Why not avoid all this confusion and lock into a fixed rate loan, you may ask.

That would be a particularly bad idea at this juncture.

Interest rates in the economy are poised at fairly high levels today with the 10-year benchmark gilt yield at a five-year high. Given that interest rates too tend to go through up and down cycles like other variables, locking into fixed interest rate loans now is a losing proposition for the borrower. Especially so as interest rates are bound to cool off from these levels in a year or two. That is when you should take a call on fixed rate loans.

Remember that banks and HFCs also charge a fairly steep premium for the predictability offered by those fixed rate loans. Most fixed rate home loans today charge 11.75 per cent per annum, almost 100 basis points more than floating rate loans. That’s Rs 3,500 more on your equated monthly instalment (EMI) on a Rs 50-lakh home loan for 15 years.

Then there are banks and HFCs offering fixed rates of interest for the initial two or three years after which the loan gets converted into floating rates.

If at all you are keen on some predictability in your EMIs, dual-rate loans may be one option. These loans offer fixed rates for the first couple of years which are then converted into floating rates. For instance, LIC Housing Finance offers an attractive scheme for women called Bhagyalakshmi which offers 10.35 per cent fixed for two years, after which the loan gets converted into a floating rate one.

Switch or reset?

The decision is easy for new borrowers, but what must borrowers with older loans do? Switching to a cheaper loan is an immediate option. But moving to a cheaper home loan will be futile if the new lender immediately pegs up rates.

Hence we advise borrowers to consider switching only if the rate differential between their existing loan and the new one is at least 50 basis points. In this case interest savings will be significant and it will also insulate borrowers from future rate hikes.

There are two ways of making the switch and reducing your EMI. One option is to reset your loan rate with the same bank. The other option is to switch to a new lender offering a lower rate. The decision has to be based on a cost-benefit analysis.

Cost: When you try to reset your interest rate within the same bank, the bank will usually charge a conversion fee based on the nature of the loan. If you want to move from a fixed rate loan to a floating rate loan, then the charges are usually in the range of 1.75-2 per cent on the loan amount and also include service charges.

For instance, ICICI Bank charges 1.75 per cent in case of conversion from pure fixed loan to floating rate loan, while Axis Bank charges 2 per cent. However, in case you want to convert your higher floating rate to a lower floating rate loan, then the charges are around 0.5 per cent in most cases.

In case you switch between banks, prepayment charges for floating rate schemes have been done away with. But there is a charge in the case of pre-closure of fixed loans. In most cases, the penalty is around 2 per cent on the loan outstanding. Besides this, a processing fee, which ranges from 0.5 to 1 per cent of the loan is also charged. There could be an additional service charge too. Here again, SBI is the only bank that offers to take over your loan at a flat Rs 1,000 (valid till th September 30, 2013), an option you must certainly consider.

Benefit: The benefit clearly is the interest savings you make on swapping your loan. The size of the benefit varies with the amount of loan outstanding (the higher the amount, the more you save), remaining term of the loan (longer the term, higher the savings) and the interest differential (bigger difference means more savings).

What do you save?

So how much exactly would you save for taking all this trouble? Let us assume that you had taken Rs 50 lakh home loan for 15 years at 10.4 per cent. After the recent hike you are now stuck with a home loan rate of 10.65 per cent. The lowest rate now offered by SBI at 10.1 per cent offers more than a 50 basis point reduction in your interest rate. If you decide to move to this scheme, then your EMI will come down by Rs 1,699 to Rs 54,036.

This amounts to savings of Rs 3,05,868 in interest over the tenure of the loan. If you can manage to pay the higher EMI and reduce your tenure instead by one year, your savings will nearly double.

Even if SBI increases the rates by say 25 basis points, you will still save Rs 930 per month on your EMI and Rs 1,67,385 on your entire interest outgo. Remember, in the case of SBI, the takeover fees (on switching from other banks) is capped at Rs 1,000. This makes it more attractive.

However, in case of switching from a fixed rate loan to a floating rate one, remember there is an additional prepayment charge of 2 per cent which may shrink the benefit. In this scenario, only a rate differential of 1-1.5 per cent will make the deal worthwhile.

The markets may wait with bated breath for the RBI’s September 20 review to decide which way interest rates will head. But as a home loan borrower, there’s no need for you to wait. It is best to do your homework now.

Hike your EMI, save money!

When you take a floating rate loan, you have no choice but to track the rates closely so that you don’t get a raw deal.

But here’s another trick to save on those Equated Monthly Instalments (EMIs). When rates rise, ask the bank to increase your EMI rather than the term of your loan. That saves you big bucks.

Here are the numbers.

Let us consider what happened to your EMI when the rates went up. Suppose you had taken a floating rate home loan for Rs 50 lakh at 10.4 per cent for a tenure of 15 years.

The EMI for this loan would work out to Rs 54,960, with total interest outgo at Rs 48,92,868 over the term of the loan. If your bank pegged up rates to 10.65 per cent, your EMI would increase to Rs 55,736 and interest over the tenure of the loan would go up by a total of Rs 1,39,579.

However, when rates change, banks by default alter the tenure of the loan and not the EMI. In this case, the tenure would go up by 6 months, but thanks to the wonders of compounding, your total interest outgo over the tenure of the loan would have increased by Rs 3,38,738.

You could have got away with half that amount had you opted to adjust for rates in your monthly instalment.

Thus, as a ground rule, if interest rates go up, ask for an increase in EMI which, in this case, amounts to just an additional Rs 775 a month. When rates decline, though, it pays to reduce the tenure of your loan as then, your total interest outgo will be much less.

Source : http://goo.gl/6xhqLV

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