Home loan rates have started increasing. Experts expect interest rates to rise by 200 basis points in two years. This will increase the tenure of your home loan and your interest burden. However, small changes to your payment plan can ensure that your loan does not escalate and you become debt-free on time.
Here are some things you can do right now to make it happen. For example, the sample numbers we’ll use here are—a minus 50 lakhs at 7% for 20 years, where the EMI is 38,765 and the interest is 43.03 lakhs.
refinancing your loan
First, understand your loan benchmark. Every loan has one. Benchmark is the lowest rate at which a loan can be given. Most bank loans have been linked to the repo rate since October 2019. Loans before that time are linked to MCLR from April 2016. Earlier this was the base rate.
Non-Banking Financial Companies (NBFCs) use prime lending rates. Repo-linked loans are the cheapest today. But only banks provide them. You can refinance your loan from bank to bank, NBFC to bank, or bank to NBFC. the choice is yours. Do a cost-benefit analysis of each option.
Refinancing happens in two different ways. First, you can ask your own lender to lower your rate. You will have to pay a small processing fee – generally, a few thousand rupees. One of two things could happen here. One, if your loan is with an NBFC, but your benchmark is unchanged, you will get a lower rate. Or two, if your loan is with a bank, you can be transferred to a lower rate repo loan. You can refinance even if the difference between the rates is less – say, 25 basis points. Refinancing the above loan at 6.75% for 20 years reduces the interest 41.24 lakhs. Hence, it temporarily cushions you against rate hikes.
Secondly, your loan can also be refinanced by transferring it to another lender who offers you better terms. This is called loan balance transfer. It involves more paperwork and costs more. You will need to pay processing fees, legal fees, and mortgage registration fees. Typically, these costs range between 0.5% to 1% of the loan. Transfers make sense when the difference in rates is large – eg, 50 basis points or more – and when you are closer to the start than the end of your loan tenure.
increase your EMI
When you refinance, you can get the benefit of lower EMI. This sounds useful and leaves you with higher disposable income. But consider alternatives. You can keep your old, high EMI. It helps in repaying the loan faster. In the above example the loan of 50 lakhs, your EMI is 38,764 7% more 38,108 at 6.75%. If you refinance at 6.75% but pay the original EMI (basically, 656 per month more), it reduces the eight EMIs from the loan and reduces your interest 39.57 lakhs.
Higher EMIs essentially provide you with micro pre-payments, thereby helping you bypass the requirement that the pre-payment should be worth at least one EMI. As your disposable income increases over time, you can pay higher EMIs. In the above 6.75% calculation, assume you have chosen to increase your EMI 50,000 This reduces your loan from 240 months to 148. It also reduces your interest 23.68 lakhs. This is a powerful option.
smart prepayment
The one-time lump sum prepayment wipes out the excess interest from the rate increase. For example, if your 50 lakh loan rate for 20 years is 7.25% by 25 basis points, your interest rate goes up to 44.84 lakhs. It also adds 11 EMIs to the loan. but instant bullet payment 1 lakh additional EMI wipes out.
The other option is to prepay systematically. We believe that the optimum prepayment for a home loan is 5% of your loan balance once every 12 months. This method helps to repay a 20 year loan in about 12 years assuming a constant rate. This is the optimum. You can always go faster if you want. The idea is to use more of your savings for investments and wealth creation. A combination of the above options will also help. What you should not do is not work. This will increase your interest to a great extent.
Worst case scenario, if your 7% loan has gone up to 9% in two years, you can look at over 100 additional EMIs. These can become a hindrance in the fulfillment of aspirations like retirement or children’s education. You wouldn’t want that.
Adil Shetty He is the CEO of Bankbazaar.com.