With some banks slashing rates and NHB removing the last hurdle to home loan portability, it has become feasible for borrowers to switch banks for lower interest rates. Here’s how to reduce your loan burden.
There’s good news on the home loan front. Last week, the country’s largest bank, State Bank of India (SBI), cut interest rates on its home loans, unleashing what appears to be a rate war. Indian Overseas Bank has followed suit. The catch here is that instead of bringing down the base rate, to which all home loans are linked and which would benefit both new and existing borrowers, banks are choosing to bring down just the spread, which means that only new borrowers stand to benefit. The interest rate on home loans has two main components—base rate and spread. Base rate is the rate below which the bank cannot lend, and spread is the margin based on customer- and productspecific factors. In the case of SBI, for instance, while the existing borrowers will pay 10.5% interest, of which 10% is the base rate and 0.5% is the spread, new borrowers will end up paying only 0.25% as spread, or 10.25% as interest rate.
So what can the existing borrowers do? Those who were lured by teaser loans at 8-8.5% in the past two years are in a quandary because their interest burden has increased to over 11.5% as the rates automatically switch to floating rate. To be sure, all loan takers are in the same boat given that the RBI raised its key rates 13 times between 2010 and 2011.
The best option available is to shop for the best loan rate. The National Housing Bank, the housing regulator, removed the last hurdle in complete home loan portability last week by revising its earlier decision, where it had said that dual rate loans (fixed for initial years) would be classified as fixed rate loans, if at the time of signing the contract the loan was subject to a fixed rate. A big chunk of home loans taken during 2009-11 comprised dual rate loans and the move is likely to benefit many borrowers as they are now switching to floating rate, which does not incur any prepayment penalty.
With the SBI signaling a rate war, home loan borrowers may finally be able to shift without paying a penalty. Of course, shopping for cheaper interest rates has been possible for a while now, but it wasn’t feasible because of the similar rates that most banks offered. This seems set to change now.
The first step to benefit from portability is to get over the inertia. Switching a home loan is not as Herculean a task as many think it to be. Just because a home loan is the biggest debt you have does not mean that the effort involved in moving it to another bank will be as great. The process is more detailed than small-ticket loans, but representatives from the new bank will help you through the process. The effort on your part would be limited to negotiating the best rate. However, keep in mind the remaining term of your loan before rushing headlong to switch. If your loan has less than 10 years to go, the benefit may not be as spectacular (see table). Also, when the interest rate is lowered, don’t reduce the EMI as this will mean a longer tenure and higher interest cost. Instead, bring down the tenure. If you don’t care to go rate shopping, try negotiating with your existing bank. You could also convert to the new rate being offered by your bank. Between two banks who offer you the same effective rate, choose the lender that offers you a lower spread above the base rate. Now, for the bad news.
Switching home loans, be it with a new bank or opting for a lower rate with your existing bank, involves costs and it’s best to decide after factoring them in. Most lenders charge a processing fee, which can range from 1-1.5% of the outstanding loan. The SBI’s existing borrowers can take advantage of the new rates only after paying a conversion fee of 1% of the outstanding loan. Some banks also levy a fixed processing fee of 5,000-10,000. Then there are hidden charges like legal fees which you need to watch out for.
With the approaching festive season, more and more banks are expected to start rolling out ‘special rates’, so keep an eye out for the best deal.