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Before you switch your home loan... Indian Express        2013-06-20
Home buyers had been facing a scenario of high interest rates which was in existence for a very long period of time. However, during the current year the scenario looks different with the Reserve Bank of India lowering key policy rates. It is widely expected that the central bank would continue to lower rates in its forthcoming announcement. Many banks, in response to the rate cuts, went ahead and announced lower interest rates on home loans, with State Bank of India taking the lead. Moreover prepayment charges on loans have also been abolished in line with RBI guidelines. With these changes happening, how can anyone not be tempted to switch to a bank with lower rate of interest?
Before you decide to take the plunge, halt, and evaluate. One should take into account key considerations before switching loans.
 
Interest rate variation
 
Check the existing rate of interest and the interest that you have been offered now. If the new lender's rate is at least 1-1.5 per cent cheaper then it makes sense to switch.
 
For example, on an existing loan of Rs 75 lakh charged at 12 per cent for 20 years, your current EMI is Rs 82,582. If there is a reduction by 0.5 per cent, your EMI will change to Rs 79,982, a difference of Rs 2,600. However, if the interest rate comes down to 10.5 per cent, the savings would be substantial with your new EMI at Rs 74,879, which means savings of Rs 7,703.
 
Remaining tenure
 
It is a known fact that during the initial years of a home loan, major component of the EMI outgo is towards repayment of the interest component and a small part goes towards repayment of the principal amount, however this changes as the years increase.
 
For the loan of Rs 75 lakh at 12 per cent cited in the previous example, out of the EMI of Rs 82,582, the interest portion stands at Rs 75,000 and only Rs 7,581 goes towards principal reduction for the first month. So to get a better deal, it pays to switch during the initial years of the loan.
 
If you are servicing your loan at a very high rate of interest like 14-15 per cent (with interest rates continually being hiked), a switch towards the latter half of the tenure may still be beneficial, but you need to figure out how much interest remains to be paid to arrive at an accurate picture.
 
A good online loan calculator would show that the savings from switching is lowest when the remainder of the tenure is five years or less. If a switch is carried out towards the later part of the tenure, a significant proportion of the interest component would already have been repaid and the benefit from switching the loan is lost.
 
Processing fees for new loans
 
A new lender would typically charge a processing fee ranging from 0.25-1 per cent of the outstanding amount. The country's largest lender, SBI, has currently capped the processing fee to maximum of Rs 10,000. Depending on the amount of loan outstanding, the processing fee will be a determining factor for deciding whether to switch loans or not. The processing fee should be lower than the cost saving that you would make on the interest differential.
 
However, here you have a catch-22 situation, as the amount of loan will be higher during the initial years of the loan and that is when the switch is more beneficial. But on a higher amount, the processing fee would also be higher. Further, some banks also charge a legal fee for property verification and such added extra costs. This also needs to be figured in the net savings available.
 
It is not possible to decide whether to switch or not based on a single cost. We will have to work a combination of all costs and decide prudently.
 
One can also try renegotiating the loan with the existing lender at lower rates to avoid processing fee. No lender would like to lose a borrower with good credit history. Hence this option could be explored before actually opting for loan switch from a different lender with its accompanying hassles.