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Switching a home loan can be tricky

Housing finance companies have increased home loan rates in the recent past. Customers may think of switching to other lenders , but this may not be prudent or easy as thought to be, as there are various costs involved.

india Updated: Oct 12, 2013 00:15 IST
Saurabh Kumar

In August, it was private lenders such as ICICI Bank Ltd, Axis Bank Ltd and Yes Bank Ltd which hiked their base rates. Then around a month later, just before the Reserve Bank of India (RBI) was set to announce the monetary policy review, State Bank of India increased its base rate thus affecting home loan rates as well.

RBI in its review increased the repo rate, the rate at which banks borrow from the central bank for the short term, by 25 basis points (bps).

Housing finance companies, too, have increased home loan rates in the recent past. Though it is too early to say whether all banks and other home loan providers will increase rates soon, but they may follow suit.

This may be the time when a lot of existing home loan customers may think of switching to other lenders to lower their equated monthly installment (EMI) outgo.

However, this may not be prudent or easy as thought to be. There are a lot of factors that one must consider before making such a move.

“There are various costs involved in switching and one must calculate the total outgo in the long term before taking a decision,” said Ranjeet S Mudholkar, vice-chairman and CEO Financial Planning Standards Board India. Here’s a rundown of all such scenarios and factors.

Costs involved

Usually, when banks increase their home loan rates the EMI does not shoot up. Instead, banks increase the tenure of the loan repayment keeping the EMI constant. However, the principal component in the EMI goes down and the interest component increases.

The number of installments will depend on the outstanding principal amount and interest is charged on this amount.

“The bank will give you various combinations of repayment and a small increase in principal repayment may bring down the tenure of the loan and the small amount will not pinch you much,” said B Srinivasan, a Bangalore-based financial planner.

As per RBI direction, though there are no pre-payment or foreclosure charge levied if you are on a floating rate loan, it may be charged if you are on a fixed rate. Also, the new lender may charge an upfront processing fee as well. All these need to be factored into the calculation as well.

Lastly, different banks have different margins of disbursing loans. For instance, one bank may give 80% of the cost of the property as loan whereas another may give at 90%.

So if you were with the lender giving 90% loan amount and want to move to the lender giving 80% of the property value, you will be required to pay the differential from your pocket. You may have paid some part of the loan already, but remember since you pay more interest during the start of the loan period the principal outstanding will be almost the same. Unavailability of funds at that point may save you from making the switch.

Possibility of new bank hiking its rate

It may not turn out to be a great idea if you switch to a new lender and the new lender subsequently hikes rates as well.

Though this may not be an easy thing to gauge but one should wait for the rate hike cycle to finish before taking such a decision. Banks which have stable rates are the ones one should look for.

There are various resources available on the Internet where one can see the trend of loan rates of a particular lender. This will give you an idea about the stability of bank rate change behaviour.

Acceptance by bank

Though you may identify a new lender and approach to switch, you may be denied on various grounds. Say for an under-construction project, if it is not approved by the new lender it will not allow you to switch.

Moreover, even if the project has got approval but is delayed due to any reason the lender may refuse to accept your proposal to switch the loan. Also, the new lender will look at your repayment behaviour with the earlier lender and if you have been erratic with payments, you may fail to secure a fresh loan.

A bank may also not accept your proposal if major part of the loan is already repaid because it may not make business sense for the new lender.

Keep in mind

Remember that it is important to keep in mind that a major part of the repayment should go as principal repayment.

“From the taxation angle, exemption is available only for Rs. 1.50 lakh of interest repayment. So rather than paying more of interest one should repay more of principal amount,” said Srinivasan.

Also if it is a marginal change then it may not make sense to move because there is a lot of paperwork and time involved.

Additionally, one bank may have a ripple effect on other banks. So, you may move to another bank and it may increase rates soon after. It is said that one must not run after uncertainty by leaving the certain.