Adhil Shetty | Last Updated: February 15, 2017 | 13:23 IST | Business Today
Over the last two years, the Reserve Bank of India has steadily reduced lending rates. Any rise or fall in the RBI’s repo rate will have a direct impact on your home loan interest rate. Therefore, in the recent past, lenders have reduced their interest on home loan products in tandem with the lowering of repo rate. Additionally, several lenders took an axe to their own lending rates following the culmination of the 50-day demonetisation drive.
In an ideal scenario, existing loan owners should benefit from these rate cuts. But in the past, this wasn’t often the case, with repo rate cuts not being adequately transmitted to borrowers. Which is why the RBI mandated banks to switch to the MCLR regime from the base-rate regime.
Since April 1, 2016, all new loans are linked to the bank’s marginal cost of lending rate (MCLR). These loans are more responsive to rate cuts in the sense that the rates change automatically on specified intervals of time mentioned in a loan agreement.
The question now is this – if you have a home loan now, should you consider transferring to another loan with a lower interest rate?
What existing borrowers can do
If you borrowed before April 1, 2016, your loan would be linked to the base rate, which is known to be less responsive to rate cuts. Assuming that you’re paying over and above the prevalent interest rate (in the region of 8.6%), you may be tempted to move to a cheaper loan. But this decision should be arrived at after carefully calculating the benefits of the transfer.
Lower interest rates are not the only reason why you should transfer your loan. You also have to look at the quantum of long-term savings as well as loan transfer costs.
Here’s a look at how you can weigh your transfer benefits.
The transfer costs: Transferring to another loan with your current lender may not involve costs. However, transferring to another lender will cost you some money. You have to pay processing fee on the balance of the loan transferred, administrative expenses, pre-payment penalty if you had a fixed rate loan, legal charges, stamp duty, etc. The aggregate of these costs lower the savings you make on the transfer.
The Remaining Tenure: If your loan is nearing its end, a transfer may not make sense. You may save costs on EMIs, your loan transfer costs may outweigh any savings.
The Long-Term Savings: This the gross of what you will save over the remaining term of your loan through a reduction in your EMIs, factoring in the transfer costs. If your savings appear to be significant, you have a case for transferring to another loan. Don’t forget that any MCLR-linked loan you move to will have a fluctuating interest rate. Currently, the interest rates are low, but at some point in the future, the rates will start increasing again due to factors such as inflation.
When It Makes Sense To Transfer
Here’s a look at the illustration below to understand when transferring your home loan makes sense.
Suppose you had taken a home loan for Rs 25 lakh for 20 years at an interest rate of 10.50% per annum. You want to transfer this loan to another bank offering you an MCLR-linked interest rate of 9.5% per annum. Now, consider the two different scenarios.
Conclusion – Shift, Only If There Are Savings
As the illustrations reveal, opting for a loan transfer in Scenario 2 is not an economical option for the borrower. It could lead to a loss, therefore the borrower can stick to his current repayment plan.
In fact, he can make the best use of the prevalent low interest rates and pre-pay on his loan. This would help him make significant progress in terms of repayment, and put him in a stronger position when the interest rates start rising again.
Conversely, when there’s a sizeable part of the loan tenure remaining, there may be significant long-term savings from moving to a loan with a lower interest rate.
In conclusion, do not make a hasty decision related to your home loan transfer. Calculate all the costs of transfer. You can take the help of various online calculators to calculate these costs and your savings. You could also approach your lender to ascertain these numbers.
(The writer is CEO, BankBazaar.com)