Check out: Answers to 3 home loan issues

1. Should I prepay my home loan?
2. What happens if I can't make my EMI payment?
3. My bank isn't lowering the rate, should I switch lenders?

Let's get started.

1. Should I prepay my home loan?

The answer to this one depends on a couple of things.

Firstly, what rate are you paying currently?

Secondly, what rate of return can you earn on your investments over the next 10 years?

If the home loan rate of interest is higher than the rate you could earn on long term investments, it is better to prepay your home loan. If however your long term investment return rate is potentially higher than the rate of interest you are paying on your home loan, it would be better to invest the surplus funds.
So, compare the two rates and you'll see whether it's a good idea to prepay your home loan.

The concept behind this is the opportunity cost of your money.
Let's break it down with a simple example.

Imagine you have a home loan where the interest rate is currently 11.50%.
You have received a bonus at work and hence have a surplus couple of lakhs at your disposal. You're wondering if it makes sense to prepay the home loan to this extent, because you know it would reduce the remaining tenure, which doesn't seem to have changed despite the fact that you have been paying your EMIs regularly for the last few years. This is because of the gradual increase in interest rates over the last few years. You understandably feel frustrated and are therefore considering putting your bonus towards your home loan.

But, wait.

If instead of prepaying your home loan to that extent, you were to invest this money towards your retirement, would you invest in equity, or debt, or a combination of the two?

Consider that you have about 10 years or more left to retire. The recommended asset allocation for a timeline like this one is 70% equity - 30% debt, broadly.

Assuming a 12% p.a. rate of return on equity in the long term and a 7% p.a. post tax rate on debt, a 70 - 30 allocation would yield you 10.50% p.a. over the long term.

So your home loan interest rate of 11.50% is higher than the return you would earn with your investments (10.50%).

In this example, your surplus funds would save you 11.50% interest, as opposed to earning you 10.50% interest, if you were to prepay your home loan.

Here, it would be financially savvy of you to prepay.

Also keep in mind that when prepaying, you are prepaying the principal component of your home loan and hence you will receive a benefit under Section 80C to the tune of Rs. 1.50 lakhs (as per current IT laws).

2. What happens if I can't make my EMI payments?

This situation is one that deserves your complete attention if you ever find yourself in it.

The first thing to do, is not to run away from your bank. Call them immediately. Indicate that you are having trouble with your payments and would like to meet to figure out your options.

Banks don't want to harass you, they don't want to write you off as a Non Performing Asset (NPA) as this makes them look bad. They do want you to repay as much as you can. For a bank, the ‘genuine intent' to repay your home loan or any other loan is what will work for you.

Here are what your options will likely be:

a. Refinance your loan (your most likely to be used alternative)
b. Lump Sum Settlement (feasible for small loans such as car loans, personal loans, credit card debt)
c. Deferral of Payments (for those who expect a positive change in their financial situations in the next few months)

3. My bank isn't lowering the rate, should I switch lenders?
In the last month, housing finance companies and banks have slightly reduced their home loan rates. Even a slight reduction of 0.25% to 0.50% can have a significant impact on your total interest repayment over the tenure of your home loan, so it is important to keep an eye on whether your bank or HFC has dropped the rate or not, especially if other banks and HFCs have dropped theirs.

Not only that, has your lender dropped the rate for you or just for its new customers? And if the rate drop doesn't include you, what can you do about it?

The first thing to do, as in Question 2, is call your bank.

It helps if you have a good credit score ( know more about your Credit Score ) and have been making your EMI payments on time, as this strengthens your bargaining position.

The last thing you should be when trying to get a low home loan rate, is shy. Your bank, with a little bit of pressure, will reduce your rate if it can. But you need to do your homework first. Speak to other banks and find out what rates they are offering to new / switching customers. Once you have this in writing, show it to your bank and ask them to lower your rate in line with the rates available outside in the loan market. The one thing you need to keep in mind is this: your bank would rather retain you and earn a little less interest from you, than lose you and your interest altogether, especially if you are a responsible customer, as most people tend to be. It doesn't hurt to remind your bank of this if need be.

A Home Loan is the single largest liability you will ever take on in your lifetime. Give it the attention it deserves, on an ongoing basis, and you can with just a little work, ensure that you make the most out of it.

PersonalFN is a Mumbai based Financial Planning and Mutual Fund Research Firm.