Hop for cheaper home loan...

It took two policy rate cuts by the Reserve Bank of India and a lot of clamouring by borrowers for banks to finally start reducing their base rates — the rates to which all lending rates are pegged. Over the past month, several banks have lowered their benchmark base rates by 15-25 basis points, making home loans cheaper. Now, this is clearly good news for new borrowers.

But what about existing borrowers? If you have opted for a home loan at a higher rate, should you move to cheaper loans? Moving over to a cheaper home loan may seem like the obvious choice, but there are costs involved. You should make the switch only if it means a substantial reduction in your monthly EMIs.

Here is how you can do a cost-benefit analysis to make your decision.

How much do you save?

First, you need to work out the amount you will be saving on your interest if you make the switch to a cheaper loan. This will depend on the amount of loan outstanding, remaining term of the loan and the interest differential. The higher the loan amount, the longer the term; or wider the interest difference, higher the savings.

To work out the interest savings you can make use of the online EMI calculators available on various bank websites. After the recent cuts, base rates of most banks are at 10 per cent while the lowest is at 9.75 per cent. Variable home loan rates — the ones that are pegged to the movement in base rates — are now offered at as low as 9.85 per cent (for women borrowers) to 9.9-9.95 per cent.

Now, let’s assume that you had a Rs.60-lakh outstanding home loan with 15 years left, at 10.25 per cent. Your EMI in this case works out to Rs.65,397.

If you are looking to switch to a lower rate, say 9.9 per cent, then your EMI will be Rs.64,109. You thus save about Rs.1,288 on your EMI and about Rs.232,000 over the entire term of the loan. Significant savings, wouldn’t you say? But you need to weigh the costs too.

Switching costs

If you want to hop over to a cheaper loan, you can either make the switch within your existing bank or choose a new one that offers lower loan rates.

When you a switch within the same bank, the bank will usually charge a conversion fee based on the type of loan. If you want to move from a pure fixed-rate loan to a floating rate loan, the charges are usually 1.75-2 per cent on the loan amount and also include service charges. The conversion charges are much lower if you want to switch from a higher floating rate to a lower floating rate loan. Here, the charges are around 0.5 per cent of the loan amount in most cases. But if you are looking to switch from one bank to another, you have to first take into account the pre-closure charges of your existing loan. In case of floating rate schemes, pre-payment charges are not applicable. Fixed-rate home loans, though, still carry a penalty.

In most cases, the penalty is around 2 per cent on the loan outstanding. After you foreclose your loan and go for a fresh loan from another bank, you have to pay the processing fee, which ranges from 0.5 to 1 per cent of the loan. There could be an additional service charge too. Ideally, it’s best to make the switch if the interest rate differential is at least 40-50 basis points, particularly if you have taken a fixed home loan.

Further, the benefit of switching is minimal if you are nearing the end of your loan tenure, since most interest payments are already made.

Reduce your loan tenure

If you decide to stay put with your existing home loan, you can still save some money by choosing to reduce your tenure rather than lower your EMI. Usually, when banks tweak their loan rates, they alter the tenure of the loan and not the EMI. Using the same example above, if your own bank reduces rates by 35 basis points to 9.9 per cent, then you should be paying Rs.1,288 lesser on your EMI. But if your bank alters the tenure instead while keeping the EMI unchanged, the period of your loan will reduce by about seven months.

Your total interest outgo over the tenure of the loan would have declined by Rs.251,000, even if your EMI remains constant. Thus, as a ground rule, when rates decline, reduce the tenure of your loan for more savings.