Balance transfer: Assess the gains before shifting your home loan

So, should you switch to the new repo-rate linked home loan? And if your bank isn’t yet offering you such a loan, what should you do?

External benchmarking

The current home loans offered by banks are based on the MCLR (marginal cost of funds based lending rate). The FM has asked banks to link their home loans to repo rates instead.

“Since external benchmark linked home loans are better than MCLR based loans, existing customers should be shifted to the former. Also, banks should be stopped from offering both MCLR linked home loans and external benchmark linked home loans simultaneously, which is the case with lenders such as State Bank of India. It leads to confusion at the consumers’ end,” said Sukanya Kumar, founder and CEO of RetailLending.com.

Though external benchmarking means effective transmission of interest rates and is seen as beneficial for home loan customers, there may also be hikes in interest rates if RBI hikes the repo rate. State Bank of India, Citi Bank, Federal Bank and Union Bank are offer home loans linked with external benchmarks.

So, is this the time to switch to the new repo rate linked loan? Or should you continue with your exiting loan for now? A lot depends the interest rate trajectory.

More rate cuts expected?

Experts seem to be expecting a benign interest rate environment for the foreseeable future. A recent report from Bank of America Merrill Lynch titled ‘Lending rates cuts? 50 basis points by March’ has the following observation from its India economist Indranil Sengupta:  “We grow more confident of our call of a 50bp lending rate cut by March after State Bank of India's 15 basis points MCLR cut (30 basis points  in this financial year so far).”

Another Bank of America Merrill Lynch report states that there is a 30 per cent plus chance of a recession in the US within the next 12 months. “If there is a recession, the global commodity prices will go down and that will reduce inflation and drive down interest rates to 4.5 per cent,” says Indranil.

He expected greater transmission of policy rates from banks in the coming weeks by way of reduction in MCLR.

“RBI has cut repo rate in the past and may cut once more in this year. More than rate cuts, infusion of liquidity in the system and other efforts to increase transmission of interest rates will lead to lower interest rates in the near future,” says R Sivakumar, head fixed income, Axis Mutual Fund.

Many banks have cut their MCLR in the past month and on an average 20 basis points rate cut has taken place. Of course, that does not mean your EMI amount will be reduced next month. Here is how it works.

Re-pricing existing loans

Balance transfer is a cumbersome process and, the time, efforts and costs sometimes eat into your benefits. However, you can still reduce your EMI burden by re-negotiating with your existing lender. “Existing lenders generally are willing to reduce the difference between existing rate of interest and the ongoing interest rate in the home loan market if it is significant,” says Vinayak Kulkarni, a Mumbai based independent investment advisor. The rate so offered may not match the best offer in the market, but may be close to it. It may be attractive enough to continue with your existing lender and, more importantly, it saves all the efforts you need to take in carrying out a balance transfer.

Effective balance transfer

If your existing lender is still not willing to budge or you face service quality issues, it may be advisable to transfer to a better financial institution offering attractive interest rates. Recently, housing finance companies were barred from levying any foreclosure charges on floating rate home loans by the regulator. Of course, many large housing finance companies stopped levying foreclosure charges from May 2014 itself.

But many smaller housing finance companies and non-banking finance companies (NBFC) had foreclosure charges. If you are a customer of one such lender, you may think of jumping at the first offer. But do not ignore costs. “Your existing lender may not charge you anything towards foreclosure charges while refinancing. Your new lender may charge you processing fee, administration fee, legal fee, valuation fee, along with premium for a new insurance policy and statutory fees,” says Kumar. Do take into consideration the outgo on these accounts; negotiate with the lender on all the fees. The bearish sentiments in the property market may force lenders to offer you some waivers if you have been a good customer in terms of having a high credit score.

Valuation and LTV

Changes in the valuation of the property can affect your loan transfer plans significantly. For example, let’s say you bought a property two years ago for Rs 1 crore and at that time the lender gave you a loan of Rs 75 lakh, applying a loan to value (LTV) ratio of 75 per cent. Assuming that you have an outstanding loan of Rs 72 lakh now,  and if you decide to move to some other lender and if the financial institution values the property at only Rs 85 lakh, then the maximum loan offered would be Rs 63.75 lakh.

“If the value of the property has fallen drastically then applying the same loan-to-value ratio will lead to a gap between new loan amount on offer and existing outstanding loan. Similarly, if the existing lender has funded using very high loan to value ratio and the new lender is offering loan within what is allowed in regulation, then the borrower has to fund the difference from his pocket,” says Hemant Kadam, a Mumbai based chartered accountant.

If you have taken a loan from NBFC companies that are facing serious liquidity crisis and / or charging you high rate of interest on your home loans, you would be better off moving to another lender to take advantage of falling interest rates.