A declining interest rate scenario also leads to several people opting to refinance their home loan.
Sanjeev Sinha | ET Bureau | 17 May 2016, 11:00 AM IST | ET Realty

Refinancing a home loan means availing a new loan from another lender to pay off an existing one. Two primary reasons for switching a housing loan (also known as refinancing) are:(1) To get the benefit of a lower rate of interest and (2) To avail a top-up on the original loan amount. However, besides these two, there could also be many other reasons for taking a new loan to pay off an older one. These can be poor service quality of the existing lender and consolidation of loan portfolio, among others.

Here we take a look at five most common and compelling reasons for home loan refinance:

1. Saving on interest cost: This is the most common reason for shifting the home loan to a new lender. If an individual, for instance, is paying higher interest on an existing home loan than that offered by another lender, he would naturally be tempted to go for a new loan that brings down his total interest cost and consequently his EMI.

A declining interest rate scenario also leads to several people opting to refinance their home loan. It is common knowledge that most home loans are floating rate loans, which means they are linked to overall macro interest rate movements. Not all lenders reduce the interest they charge on their loans when the general interest rates in the economy fall. Some lenders reduce their rates after a lag and some do not reduce the rates as much as the base rate declines.

“It is often seen that when home loan rates move upwards, all customers’ loan rates tend to go north. However, there is a possibility of the rates of not all loans coming downwards in the reverse situation. This also makes home loan refinance an attractive option as your current loan gets adjusted to prevailing market interest rates, giving you significant interest cost savings and reducing your monthly EMI burden,” says Parth Pande, co-founder of Finance Buddha, a marketplace for retail lending products.

2. Moving from floating rate loans to fixed loans or vice versa: Home loan customers may be in any of these two scenarios. They may be paying a high floating interest rate and therefore are likely to see value in moving to a fixed rate home loan, in which case their EMI will be constant for a certain period of time. Alternatively, they may be stuck with a fixed home loan at a higher rate (fixed rate loans typically are at a higher rate than floating rate loans at any point of time). In this case, they may realise that the overall interest rates have moved southwards and floating rate loans are much cheaper than their existing loan and there is value in switching the loan. In both these scenarios one may like to opt for refinance.

Let us take the example of an individual who had opted for a 20-year fixed rate home loan of Rs 50 lakh at 12.25% per annum two years ago and is now paying an EMI of around Rs 56,000. “After paying the EMI for two years, his outstanding loan amount is Rs 48,67,866. For the rest of the tenure (18 years), he decides to shift to another bank which is offering floating rate home loan at 9.75% per annum. This way he reduces his EMI from Rs 56,000 to close to Rs 48,000 and his total interest cost comes down from Rs 84 lakh to Rs 67 lakh,” says Rishi Mehra, co-founder of deal4loans.com, a loan comparison service engine.

True, the individual may have to incur some charges for pre-closing his loan and getting his loan refinanced from another lender, but those charges are likely to be negligible compared to the savings he will be able to get during the remaining tenure of the loan.

3. Additional loan opportunity: Along with home loan refinance, customers also have an option of taking incremental funding (also known as top-up) at the prevailing home loan rates. For example, Mr A took a Rs 40-lakh loan for buying a Rs 50-lakh property 5 years back. After paying the EMIs for 5 years, let’s assume that the loan value has come down to Rs 30 lakh, however the property value has appreciated to Rs 1 crore.

“This means that Mr A can now get a home loan of up to Rs 80 lakh on this property, if he so desires. But he can’t avail the entire amount as loan as he still has an outstanding loan of Rs 30 lakh which he has to clear first before taking the new loan. In this case Mr A can get his loan refinanced from another lender to transfer the Rs 30-lakh outstanding amount at a lower interest cost, while he can also get incremental funding of Rs 50 lakh (Rs 80 lakh minus Rs 30 lakh) at more or less the same interest rate,” informs Pande.

However, you should opt for a top-up of your loan from another lender only if you are getting the benefit of lower rates, otherwise try to get it from your existing lender as that would be easier and you also won’t have to incur charges for getting the loan refinanced. “Should you plan to switch your housing loan to avail the ‘top-up’ option, I would advise you to approach your existing bank for a top-up plan, in case the interest rates are similar. If your loan repayment track record is good as well as the value of the property has appreciated, there is a good chance that the existing lender would consider your request for a top-up,” says Naveen Kukreja, co-founder and CEO, PaisaBazaar.

4. Poor service of the existing bank: If the bank from which you have taken your home loan does not service you properly- for instance, if it does not issue loan statements on time, provides bad customer care services or is slow in reacting to changes in interest rates-there is every reason for you to get your loan refinanced from a lender which is known for providing good services.

5. Change in financial status: Any increase or decrease in your income would affect your ability to service your EMIs. In case your monthly income has decreased due to any reason or another financial obligation has come up, refinancing a home loan by replacing it with one with a longer tenure is a good idea to reduce your EMI amount. “On the other hand, in case you are in a better financial position compared to when you had taken a home loan, it may be a good time to opt for home loan refinance and reduce the tenure of the loan, thereby increasing your EMI amount but making sure you will be now be able to repay your home loan sooner,” says Adhil Shetty, founder & CEO of BankBazaar.com.

Thus, apart from other benefits, one can save significantly if one refinances one’s home loan keeping in mind the overall interest rate movements in the economy. However, there is need to take some precautions.

Watch-outs

Here’s what you need to keep in mind while opting for home loan refinance:

# Try to switch the loan early on during the tenure. “It is advisable not to make the switch after 5-6 years of loan payment as you would have already paid most part of the interest amount during the initial period,” says Kukreja.

# Secure clarity on processing fee, valuation fee and other charges that will be applicable in case you opt for a fresh loan.

# Be aware of the fact that the new bank/lender would treat your request for home loan as fresh and hence, you will have to go through all procedures again. This is inclusive of legal verification of your property credentials, credit appraisals etc.

# Make sure that you get a statement from your current lender stating that all relevant documents will be transferred to the new lender within a stipulated time-frame.

# You may not be able to switch the housing loan if you have been irregular with loan repayment in the past.

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