The finance Minister has hinted at a rate cut by the public sector banks. State Bank of India, Punjab National Bank and other banks have also indicated that there would be rate cut soon. And the government has increased its focus on the continuing growth across sectors.
All these are signals of a lower interest rate regime in the immediate future, and call for smart thinking so as to reduce one’s fixed monthly expenditures through better management of equated monthly instalments (EMIs) towards home loan, car loan and personal loans.
Banks are reducing their deposit rates and their lending rates; PNB has reduced its interest rate for a 20-year, Rs 20-lakh loan from 11 per cent in December 2008 to 10 per cent in May 2009.
However, the benefits have been mostly transferred to new customers. Existing customers have little to cheer as the reduction is limited to 25-50 basis points.
Tactics for new home loan customers
There is little doubt that PSU banks will cut lending rates. And given the competitive environment, private sector banks will have no choice but follow suit. Look for a good deal with the bank for a loan. If you can wait for a few months to buy your home or car, it could be worth the wait.
If the interest rate falls by 1 percentage point from 10 per cent now to 9 per cent, the outgo for you on a 20-year, Rs 20-lakh loan dips by Rs 1,305 every month.
“It makes sense to defer the purchase by few months as even a 50-basis point difference in loan rate will make a big difference in your EMI outgo, as home loan is for the long term,” said Surya Bhatia, a certified financial planner. “As the rates are bound to go down, one must go in for a floating rate loan and should get it converted into a fixed rate loan as and when the trend reverses by paying 0.5 per cent switchover penalty.”
Existing customers of floating rate home loans who are saddled with high interest rates of around 12 per cent on their existing home loans should start looking out for better options to transfer their loans. If you manage to get a loan at 10 per cent against your current outgoing at 12 per cent, you save Rs 2,721 per month on an outstanding loan amount of Rs 20,00,000. That is a total saving of Rs 32,655 every year.
While going for a loan transfer at another bank you may be required to pay a prepayment penalty of around 1 per cent and a processing fee of around 0.5 per cent on the new loan. The total outgoing in these comes to Rs 25,000. However, you still benefit, as the saving in your EMIs in the first year takes care of both these expenses.
In case of auto loans that are fixed in nature you should always look to take the minimum loan amount possible because the loan rate on an auto loan is higher and also you don’t get saving on taxes on the auto loan. So instead of going for a fixed deposit that earns you 9 per cent pre tax, pay it as a down payment for your car purchase — if you borrow this from a bank, it would cost you around 11 per cent interest.
“Unless you own a business and can claim the interest payment as an expense to your business, you should take the minimum amount as loan for a car purchase even if it requires you to break your fixed deposit,” said Bhatia.
For existing auto loans at 14 per cent or more, go in for a balance transfer only if you get loan at a rate which is significantly lower than that and covers the prepayment penalty cost (2 per cent) and processing fee (0.5 per cent). For example if you get a loan at 10 per cent on an outstanding of Rs 500,000 for five years, you would save Rs 1,010 every month and this will also neutralise, within the first year itself, the cost of switching over.
As far as personal loans are concerned, it always makes sense to break your investments that earn even 10 per cent to pay off personal loans, which cost 15-25 per cent in interests.
It is very important to get your calculations right before you venture into a switch over. Be smart with your EMI outgo, and increase your savings to generate higher wealth.