Home loan interest rates are becoming more dynamic. Over the last year or so, the Reserve Bank of India (RBI) has gradually reduced the Cash Reserve Ratio (CRR) and repo rate. Further, there has been increased competition in the home loan market. Banks have reduced the rates on their floating rate home loans. However, as banks did not lower the base rate, existing borrowers continue to pay more than new home loan borrowers.
With the recent cuts in the key interest rates, borrowers on floating rates were also expecting a cut in the interest rate on their home loan. After all, they had borrowed at a floating rate and were supposed to float with the changes in the interest rates. However, the interest rate reductions announced were for new borrowers. They were not applicable for the existing borrowers.
As a solution, existing borrowers have the option of switching the home loan to another bank. Most banks allow a balance transfer. Further, as the RBI has waived off the prepayment penalty, you can have your balance loan transferred to some other bank without any prepayment charges.
Borrowers who are paying 1.5-2 percent higher can consider a balance transfer or switching to a lower rate at the earliest. However, the switch may not be a beneficial option for all.
An existing home loan borrower has the option of switching to a lower rate within the same bank by paying 0.5-1 percent of the outstanding loan amount as a one-time switching charge. Secondly, one can opt for a balance transfer by shifting to another bank. However, this process too involves a cost. It is just like taking a new home loan.
One should ask the bank for a cost break-up before taking the decision. The new lender will charge a processing fee to take over the loan. Usually, this is about 0.50 percent of the loan amount. Most banks now restrict it to Rs 10,000 plus service tax.
How it works
Let’s take a case study. Abhi took a loan at an interest rate of eight percent in 2006 from bank A. Over the years, the interest rate has increased and currently, he is paying an interest rate of 12 percent. Now, although the bank has reduced the interest rate to 10 percent, he continues to pay 12 percent, because the new rate is applicable only to new borrowers.
However, he has two options. One, pay 0.50 percent of the outstanding loan amount and switch to a lower interest rate of 10 percent. Two, transfer the balance to another bank offering 10 percent or lower. In the second case, he has to pay the processing fee for the new loan.
Evaluate gains first
It makes sense to transfer the loan to another bank only if the gain is substantial over the tenure. The decision will depend on various factors including the remaining tenure of the loan, difference in interest rates, outstanding loan amount and the costs involved. In case the loan has a long tenure left, it may be beneficial to switch. One needs to compare the incremental cost (processing charge and other costs) with the interest saving on the outstanding loan amount through the remaining tenure.
There will be a time lag before the two will break-even. For example, if only one year is remaining before the loan is repaid and the interest difference is 0.50 percent, it translates to an interest saving of Rs. 7,500 for the year. However, if the costs is Rs. 10,000, it does not make sense to switch.
On the contrary, if the remaining tenure is 10 years and there is an interest saving of Rs 5,000 per annum, it is worth paying Rs. 10,000 now and switching to another lender. In case you switch early, the money saved will be more. Normally, it makes sense to opt for a balance transfer if you have at least 8-10 years left on a home loan that is 15 to 20 years long or if the difference between the new rate and old rate is at least one percent per annum.
Process of switch
Abhi, as in the case study, will have to apply to another bank and submit the required documents, photo, income proof, PAN, etc. A copy of property’s documents will also have to be submitted. These will be scrutinised by the credit department to decide on the quantum of loan, tenure, etc. He will need to obtain a ‘list of documents’ from his bank specifying the original documents held by it. Also, it will issue a foreclosure letter specifying the balance loan amount that is due. The new bank will conduct a credit appraisal, a field investigation and then sanction the loan.
The new bank will give him an offer letter at which time he can submit all the necessary documents for a legal check. Once the documents are checked and the agreement signed, the new lender will issue a cheque disbursing the balance loan amount to the previous lender.
Alok Kumar Upadhayay