Low interest rates bring cheer to the loan market. Over the last two years, we’ve seen the Reserve Bank of India (RBI) lower the repo rate from 8 to 6.25 per cent. In the aftermath of the demonetisation, banks have lowered lending rates. As of May, the lowest home loan rate offered by the State Bank of India is 8.35 per cent, which is only marginally above its one-year MCLR of 8.

This lowering presents many choices before consumers. Those who’ve been aspiring to buy a home may now be able to take larger loans. Those already repaying loans can look at transferring to cheaper loans or pre-paying their loans if they are happy with the rate.

Let’s examine both options.

Switching to MCLR-linked loan

The RBI introduced the Marginal Cost of Lending Rate (MCLR) regime from April 1, to which all new bank loans with variable interest rates are linked. This helps customers receive rate cuts in a transparent, time-bound manner. At the end of the demonetisation, the SBI slashed its one-year MCLR to 8 per cent. In April, it lowered its base rate to 9.1 per cent. In May, the bank announced another rate cut with a women’s special loan offered at 8.35 per cent. Keeping in sync with the SBI, several other banks have lowered their interest rates as well.

If your loan is linked to the base rate, it’s quite likely that you’re paying an interest rate well above those of the MCLR-linked loans. You have two options here: one is to convert to an MCLR-linked loan within your own bank, and the second is to move to an MCLR-linked loan to another bank offering a lower interest rate.

Conversion and transfer costs need to be kept in mind while exercising either option. If you convert to a new loan within the same bank, you may have to pay a conversion fee. If you want to transfer, it means additional paperwork and pay processing costs. These need to be weighed against the expected long-term savings in costs which you can calculate using online EMI calculators or by working with your loan manager. The accompanying table gives an illustration of what you could save.

The switch in the example proves highly beneficial as the tenure of the loan is long. However, if you are nearing the end of your loan, a switch may not prove as useful since you may want to continue it for any useful income tax deductions.

Depending on your relationship with the bank and your creditworthiness, a negotiation in loan conversion charges is possible.

Pre-paying part of a loan

In a scenario where you’re happy with the interest rate you’re paying, you may consider making principal pre-payments. This will help you reduce your interest out-go in a significant manner. For the same loan of ₹50 lakh at 10 per cent for 20 years, let’s consider that you’ve been paying EMIs for five years. You now want to make a pre-payment of 10 per cent of your loan balance, which works out to 4.49 lakh. Your total interest outgo as per the original loan plan comes to ₹65.80 lakh from which ₹23.85 lakh has been paid in the last five years. Therefore you still need to pay ₹41.95 lakh as interest. Here, if you pre-paid ₹4.49 lakh with your 61st EMI, your interest over the remaining 15 years comes down to ₹29.31 lakh. This saves you ₹12.64 lakh.

However, assuming after five years, you transferred the loan to the MCLR-linked loan, where you’re now paying an interest rate of 8.55 per cent. Right at the start of the loan, you decide to pre-pay ₹4.49 lakh.

Now, the interest for the remaining 15 years plummets to ₹25.12 lakh. In addition to the interest already paid, you will be paying a total interest of ₹48.97 lakh. This saves you a massive ₹16.83 lakh over the original interest payment of ₹65.80 lakh. Whether a switch or a pre-payment, the bottoming out of interest rates is a great time for you to ensure significant, long-term savings. Work with your lender for the best deals.

(The writer is CEO, BankBazaar.com)

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