When Delhi-based Mahendra Gupta opened the recent letter from the housing finance company, there was both good and bad news for him. The dismal bit of information was that the 20-year home loan he had been repaying since 2008 still had 22 years to go.
Despite four years of regular repayments, the loan tenure had been extended because of the rise in the home loan rate from 10.25% in 2008 to 13% now.
The good news was that Gupta's lender was ready to convert the loan to a lower rate if he paid a one-time conversion fee. He paid Rs 7,300 and got the interest rate lowered to 10.5%. "My loan tenure came down from 272 months to 166 months. It was a straight gain of almost nine years," gushes the 35-year-old.
Gupta can consider himself lucky. Not every lender offers its customers this option. Worse, very few keep their customers updated about changes in interest rates or how they impact their repayment schedules.
Most banks just go by the wording of the loan agreement, which says the lender can increase the rate and accordingly extend the repayment tenure. If the term cannot be extended, the bank raises the EMI amount or asks the borrower to pay a lump sum.
Be a proactive borrower
You need to be proactive about your loan repayment and check the interest rate you are being charged. When the base rate was introduced, home loan customers thought they would get more transparent deals from their lenders.
However, many banks continue to discriminate between old and new customers, charging the existing ones a higher rate than that being offered to new borrowers.
If you are being charged a higher rate, ask your bank to convert it to the rate applicable to new borrowers.
Don't assume your bank will not listen to your request. A slowdown in growth and intense competition in the housing finance sector have pushed banks to the wall.
Home loan growth slowed down from 15% in 2010-11 to 12.1% in 2011-12.
More importantly, the RBI has abolished the prepayment penalty levied by banks and housing finance companies. So, shifting to another bank is not as costly as it used to be.
"The RBI move has boosted borrowers' ability to negotiate," says Kapil Narang, chief operating officer, Ameriprise India, a financial planning firm.
Banks are willing to negotiate, especially if the borrower has a good repayment history. If a bank refuses to budge, a mild threat of shifting the loan to another lender can work wonders.
"There are instances where banks have offered to cut rates when the clients expressed their intention to transfer the loan to another bank," says Vipul Patel, director, Home Loan Advisors, an independent mortgage consultancy firm.
Balance tenure is crucial
Keep the remaining term of your loan in mind when you sit at the negotiating table. When Gupta got his interest rate converted to 10.5%
from the earlier 13%, his tenure of 22 years and 8 months was cut down by 8 years and 10 months. Remember that if your loan has less than 10 years to go, the benefit may not be as spectacular. As the table shows, the benefit progressively reduces if your balance tenure is lesser.
A 1.5 percentage point cut in the rate will shave off nearly five years from a 20-year loan, but it will reduce the tenure by just 1 month if the loan has only five years to go. Since you are paying a conversion fee upfront, the change may not lead to any significant gain. Go for it only if the reduction is at least 2 percentage points and your loan has more than 10 years to go.
Cut the tenure, not the EMI
When the interest rate on your loan is lowered, don't make the mistake of reducing the EMI. It's a tempting thought because it eases the pressure on your monthly budget.
However, lower EMIs mean longer tenures and higher interest costs. Instead, bring down the tenure of the loan. "Our standard advice is to avoid reducing the EMI amount. As far as possible, one should opt for cutting down the loan tenure," says Patel.
Only if you genuinely find it difficult to pay the EMI, should you opt for a lower instalment.
This is especially true of individuals who have taken a large home loan on the basis of a projected income, but have not got the kind of pay hikes they expected.
Also, double-income families, where one spouse has lost a job or stopped working, may find this option useful.
Besides, you should check if the new rate that is being offered to you is linked to the base rate of the bank. Make sure it is not a promotional rate that is being offered to new customers. Banks offer low rates to attract customers but hike the rate after 2-3 years. Since home loan tenures are typically 10-15 years, don't go by just the short-term benefit offered on the loan. The loan agreement should clearly specify the spread between this rate and the bank's base rate.
The cost of change
Don't think you can opt for a new and lesser interest rate for free. This conversion entails a minor cost, with banks charging 0.5-1.5% of the outstanding amount (see graphic). It is also a fairly straightforward procedure, which can be completed with one visit to the bank branch.
However, switching to a new bank is a lot costlier and requires more paperwork. Even if your previous lender does not levy a prepayment penalty, the new lender will demand 0.5-1.5% as processing charges. There is also the convenience aspect. You will have to go through the entire process of submitting documents-proofs of income and identity, and PAN card, etc. Therefore, do a cost-benefit analysis before deciding to convert or switch to another lender.