Their Story. A switch in time can save you a pile

2015 was a good year for those who had taken home loans. It was a year in which the Reserve Bank of India cut the policy rate by 125 basis points.

While home loan providers were initially reluctant to bring down their rates, they were forced to pass on the benefits to their customers in the second half of the year due to increasing pressure from the RBI. Banks such as State Bank of India (SBI), ICICI Bank and leading home finance player HDFC, that were charging 10.15-10.25 per cent reduced their home-loan rates to around 9.55 per cent.

However, there is a flip-side to this tale. There are also people who had locked in their home loans at fixed rates. These borrowers are now being charged a tad higher, over 10 and 11 per cent after they switched to a floating rate. With interest rates available at less than 10 per cent now, these people have the option of switching their home loans to a provider who offers a lower rate, provided such a switch will save them money. Here we discuss two cases where the home loans are locked at a higher rate.

We examine the cost and the benefit if they switch to a lower interest rate provider and how they can go about it.

Case 1 Sanjay Kumar, a Senior Business Systems Analyst at a software firm in Chennai, had taken a home loan in 2010 from a leading home financier. His loan amount is ₹27.9 lakh, for a tenor of 20 years. He was locked into a fixed rate of 9.25 per cent for the first five years. After it became floating rates, he now pays an interest rate of 11.45 per cent which is almost 200 basis points higher than the 9.55 per cent offered by SBI or HDFC currently.

“I had opted for the fixed rate since the rates were very competitive at that time. But I was really surprised by the high rates I am charged now. I was not aware of this impending re-set, and was also not informed clearly by the service provider,” says Sanjay.

However, Sanjay came to know through advertisements and friends that he has the option of switching to a different service provider offering lower rates. He now plans to switch his loan to SBI, which offers a lower rate of 9.55 per cent.

The cost benefit analysis suggests that Sanjay has made a wise decision. He has to repay a little less than ₹25 lakh of his principal component.

If he has to continue with his existing lender, for the rest of his loan tenor he will have to shell out over ₹52 lakh (principal plus interest). Switching his loan to SBI will result in an outflow of about ₹47 lakh on the new loan plus the initial charges, which can account for about ₹30,000 to ₹40,000. So, he can save over ₹4.5 lakh on switching his home loan.

Case 2 After scouring the length and breadth of Chennai, Selvaputthiran found an apartment that was close to his wife’s office and daughter’s school. To part-fund the purchase of his home, he took a home loan in early 2013 with a tenor of 20 years.

While the interest rates were high then, he made a wise decision of locking into a fixed rate of 10.15 per cent for two years. After the lock-in period, his cost shot up. Selvaputthiran says, “The loan was switched to a floating rate of 12 per cent. But, after paying ₹1,500 processing fee, it was reduced to 10.25 per cent.”

Why does he prefer a fixed rate? Selvaputthiran’s reply is, “A floating interest rate is unpredictable. I wanted a fixed rate without any risk.”

Selvaputthiran has made a pre-payment of ₹5.5 lakh and reduced his loan tenor to 12 years from 20 years. He is also contemplating switching his home loan to a get a lower rate of interest. He has ₹24 lakh to repay from his principal.

Similar to case 1, after working the cost-benefit analysis and taking into account all the fees and charges, Selvaputthiran can save over ₹1 lakh upon transferring the loan.

Key takeaway The cost benefit will be high if the pending loan tenor is higher. If the interest differential is very high, then too, one can save a huge sum of money on the interest component as in the case of Sanjay where the rate differential is almost 200 basis points.

How to switch So, what do they have to do to switch their loans? The first step is to apply to their current provider and get a no objection certificate (NOC) for the loan transfer and other documents to show the account balance, payment history, etc.

The new bank will ask you to submit these documents before giving you a new loan. On completion of all the processes, the new lender will sanction the loan amount to the old lender for closing the loan. Finally, all the home-related documents are transferred to the new institution.

Doing due diligence For anyone who intends to take a home loan, interest rate should not be the sole factor affecting the decision. If there is one thing that people need to check before going for a loan, it is the amortisation schedule. This is a table given in the form of an excel sheet from the institution, upon request.

What is the purpose of this table, you might ask.

This table provides details such as what your equated monthly instalment (EMI) will be and also the break-up for each month’s EMI (principal and interest). This table gives you the total money outflow for the entire loan tenor.

Make use of this table to compare service providers with different rates and different tenors and calculate the total money outflow for the entire loan tenor. Of course, you will have to take into account other costs, such as processing fee and other charges as well. Many free amortisation schedule calculators are also available on the internet.

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