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Amid falling rates, it makes sense for home-loan borrower to increase his EMI and accelerate repayment of principal
By: Saikat Neogi | October 13, 2015 12:08 AM | Financial Express

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THE Reserve Bank of India (RBI) cut its repo rate by 50 basis points on September 29, taking the total reduction since January to 125 bps. But banks and housing finance companies offering home loans have cut their rates by up to 50 basis points only.

State Bank of India is offering interest rate on housing loan at 9.55% to salaried individuals. Similarly, HDFC is offering housing loan at 9.6-10.15% across all loan amounts and ICICI Bank at 9.6-9.65% for loan amounts less than Rs 75 lakh. So, if a new borrower takes a Rs 50-lakh loan for 20 years at 9.55% interest rate per annum, the equated monthly installment (EMI) will be Rs 46,770.

Lower risk weight
The central bank has also lowered the risk weights on select home loans of up to Rs 75 lakh where borrowers are willing to put in more money and lower the loan-to-value ratio. A Crisil research expects interest rate on home loans to come down by another 25-30 bps over the next few months because of this move. The RBI has lowered risk weights on housing loans of up to Rs 75 lakh from 50% to 35% in cases where the borrower puts in at least 20% of the value of the home as own equity for loans up to Rs 30 lakh and 25% of the value of the home as own equity for loans between Rs 30 lakh and Rs 75 lakh.

Home loan borrowers in smaller cities are likely to be the biggest gainers. In fact, Crisil estimates that around 80% of home-loan borrowers and 70% of home loans by value would meet the criteria for lower risk weights set by the central bank. The loan-to-value ratio for home loans has come down from 75% in the third quarter of FY10 to 66% in the same quarter of FY15, which means a higher proportion of new loans would meet the criteria for lower risk weights.

Increase EMI or tenure
Borrowers benefit from an interest rate fall, especially in case of a floating rate home loan. Also, one of the immediate benefits of a rate cut is that the new borrower’s loan eligibility amount increases. Ideally, one’s EMIs should not exceed 40-50% of his monthly income. If the EMI is much lower than this, increasing the EMI is an effective way to ensure the loan is paid out early. Increase in EMI can be requested at any point of time during the loan and, usually, there are no charges for such a request.

Whenever lenders reduce the interest rate of home loan, for an existing borrower, however, they either keep the EMI unchanged and reduce the loan term or reduce the EMI and increase the loan tenure. It always makes sense to keep the EMI amount unchanged. If possible, increase the EMI so that the interest outgo for the entire tenure is reduced significantly. Analysts say when the interest rate drops, the borrower should increase the EMI and accelerate the repayment of the outstanding principle.

For instance, an existing borrower of Rs 50 lakh who has paid for five years from the total tenure of 20 years, a 20-bps decrease in interest rate (1 bps a hundredth of a percentage point) will reduce his EMI by Rs 550 from Rs 48,583 to Rs 48,033. This would mean a total savings of Rs 99,000 as interest payment for the remaining period of the loan. On the other hand, if the borrower keeps the EMI amount unchanged and reduces the period of the loan by four months, then the net savings on interest would be over Rs 2 lakh, provided the interest rate remains the same for the entire period of the loan. One can opt to make partial payments at regular intervals, say, every six months or one year, to repay the loan quickly and save the interest as banks and housing finance companies do not charge any pre-payment penalty for principal repayment.

Loan switch
If your lender is charging you higher interest rates than others, switch the bank. Ensure that the difference in the interest rate between your existing lender and the new one is at least 75-100 bps as you have to pay processing (around 0.25% of the loan due) and legal fees to switch the existing loan to the new lender. Analysts say it will make sense to switch only if more than seven years of repayment remain. It is not always advisable to shift the home loan from one bank to the other just because of lower interest rate. The borrower must calculate the actual amount that he can save by switching the loan and after adjusting all the charges.

WHAT TO DO
* Ideally, EMIs should not exceed 40-50% of monthly income
* If EMI is much lower than this, increasing the EMI is an effective way to ensure loan is paid out early
* When the interest rate drops, the borrower should increase the EMI and accelerate the repayment of the outstanding principal
* If your lender is charging you higher interest rates than others, switch the bank
* Ensure the difference in the interest rate between your existing lender and the new one is at least 75-100 bps as you have to pay processing and legal fees for the switch
* Calculate the actual amount that you can save by switching the loan after adjusting all charges

Source : http://goo.gl/MIg3iL

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