Prepay Your Home Loan With Surplus Income In Your Hand


Home loan borrowers used to be at the receiving end when they wanted to prepay their home loans. With the increase in interest rates, it makes sense to prepay a home loan, provided the borrower’s capacity permits him to do so. A major issue faced by home loan borrowers on the floating rate scheme was the increase in EMIs when the interest rate increased. However, they hardly got any benefit from a reduction in interest rates. Banks could vary the spread between the benchmark rate and the actual lending rate. For example, assume a floating rate home loan at nine percent, when the prime lending rate (PLR) of the bank was 12 percent, and the loan was disbursed at three percent below the PLR. Assume the interest rate went to 12 percent when the PLR went to 15 percent. However, when the interest rate began to decline, the bank offered a lower rate only to new borrowers by varying the spread, ie, by offering loans at 4-5 percent spread below the PLR. In order to discourage prepayments, many banks levied a prepayment penalty. The prepayment penalty could vary between 1-5 percent, and was leviable on the amount prepaid. This increased the effective cost of the loan for a borrower, as he had to pay this money upfront, in addition to the outstanding principal.
The Damodaran Committee report on customer service observed that foreclosure charges levied by banks on prepayment of home loans were resented by home loan borrowers across the board. Also, the foreclosure charges are seen as a restrictive practice deterring borrowers from switching over to cheaper available source.
Over 90 percent of home loans that are taken from banks are on the floating rate. The Reserve Bank of India (RBI) had been requesting banks not to levy this fee. Later, it issued a mandate in this respect. The RBI directed banks not to levy a charge on a foreclosure of a home loan taken on a floating interest rate basis, with immediate effect.
With this move, the difference between the interest rate charged on a new loan and an old one is reduced. A home loan borrower can shift to another loan without incurring a prepayment charge. As a borrower can now prepay and shift to another bank, the banks are forced to bring down interest rates uniformly – for both existing and new borrowers. Till now, existing borrowers hardly got any benefit in case of a reduction in interest rates because the reduced rates were applicable for new borrowers only.
A major barrier to switching loans is now removed. However, borrowers are still required to pay the processing fee levied by the new bank. So, one would need to weigh the cost and advantages of switching to a new lender.
In case your lending bank does not reduce the interest rate when the interest rates go down, you can look at switching to some other lender. This will be of immense help to floating rate borrowers, especially in the present as well as forthcoming months, where the interest rates are expected to come down step by step. In case you have excess funds, you can prepay your loan without any fear of the prepayment penalty.



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