SBI offers lower rates on new home loans: Should you refinance your loan?

Mayur Jaiswal, 42, a private sector employee, took a home loan of Rs 50 lakh at 6.75 percent for 15 years from a public sector bank in April 2022. The interest rate has now increased to 9.25 percent because of cumulative repo rate hikes since May 2022.

Jaiswal has sleepless nights because his loan tenure has increased by about seven years, or 87 months. His repayment will now continue well into his retirement years. He also doesn’t have enough savings to increase the equated monthly instalments (EMIs) of his home loan.

However, the public sector bank is now offering home loans to new borrowers at 8.5 percent, while continuing to charge existing borrowers 9 percent and above. Jaiswal reached out to his bank’s customer service through emails and called the branch manager many times to renegotiate the rates for existing borrowers, but there was no response.

“The bank should have the courtesy to come forward and offer some kind of respite to existing borrowers,” said Jaiswal.

In March, Jaiswal applied to refinance the loan with a private bank that offered him a home loan at 8.5 percent interest, with a refinancing cost of 1 percent of the loan, i.e. Rs 50,000. To be sure, this is a one-time charge.

Jaiswal is in a dilemma about whether to take the new home loan offer at an added cost or continue paying higher interest to the existing lender.

“A balance transfer may cost 1-2% of your loan. But if you get a rate that's 25-50 bps lower, the refinance pays for itself,” said Adhil Shetty, CEO of BankBazaar.com.

He said that if the projected savings from refinancing exceeds the cost, it’s worth switching. Refinancing is beneficial for borrowers with several years of EMIs to pay. Not acting now would mean spending more years in debt later.

Similarly, Kalpesh Choudhary, 44, a marketing executive in a private firm, took a home loan of Rs 1 crore at 7 percent for 15 years from a private bank in March 2021, but the interest rate has now increased to 9.50 percent. For him, the loan tenure has increased by 7.5 years (i.e. 90 months), which is beyond his retirement age. He is also considering whether to negotiate for a lower rate or refinance the loan.

Several home loan borrowers are in a dilemma about whether to continue with their existing lender at the interest rate being charged, negotiate for lower rates with the lender, or refinance the loan.

Let’s understand why interest rates are lower for new loans and what borrowers should do in such a situation.

Also read: RBI rate hike pause brings relief to borrowers. But that could just be temporary

Rate disparity

If you apply for a home loan from Bank of Baroda or the State Bank of India, you can get them at a rate starting at 8.5 and 8.70 percent, respectively.

“But most of the existing borrowers are paying interest rates from 9 percent to 9.4 percent,” said Vipul Patel, founder of MortgageWorld, a loan consultancy firm. There is a wide gap in home loan interest rates between existing and new borrowers, he said.

The reason for the disparity in home loan interest rates is mainly due to the discretion that banks have in setting them relative to the repo rate, to which they are benchmarked.

The external benchmarking regime was introduced in 2019 primarily to ensure that the Reserve Bank of India’s monetary policy decisions – rate hikes or cuts – were passed on to consumers. Banks had to pass them on to all borrowers.

“The transmission has certainly improved, but the disparity in interest rates offered to old and new borrowers – chief cause of heartburn for existing borrowers – persists,” said Shetty.

A bank’s interest rate is calculated based on many factors, including operating costs, credit risk, and profit margin. Banks have the flexibility to decide this and once a home loan contract is signed, the spread cannot be changed for three years. The banks can, however, revise the spreads for new borrowers.

“In line with the RBI policy, banks benchmark home loans to the repo rate, ensuring transparent transmission to consumers. The whole intent of the repo-linked benchmarking has been transparency in transmission to retail customers, and the current architecture is working efficiently,” said Mohit Mehta, head – home loans at Kotak Mahindra Bank.

He said there has been a transmission of 250 bps during the course of the year, in line with the repo rate increase.

The Monetary Policy Committee’s decision of April 6 to not raise the repo rate comes as a relief to home loan borrowers who have seen a significant increase already.

As the repo rate increased, banks are squeezing their own profit margins mainly to attract new loan borrowers and give them a cushion in a rising interest rate regime.

In January 2020, before the pandemic, the repo rate was 5.15 percent and the lowest interest rate in the market was 7.9 percent to 8.25 percent, implying a spread of 2.75 basis points (bps) to 3.10 bps over the repo rate. Then, the spreads narrowed to 2.4-2.5 bps in 2022, according to BankBazaar data.

“Today, we're seeing lenders go as low as 1.95 bps spread,” said Shetty. He added that it's possible for some banks and non-banking finance companies to lend at those spreads and this benefits new customers.

The repo rate has been increased every two months since May 2022. The central bank has hiked the rate by a cumulative 250 bps since it started the rate-tightening cycle in May 2022.

For existing borrowers, the spread remains constant despite the repo rate hike or cut.

“The spread can be reviewed once in three years, as per RBI’s external benchmarking rules,” said Patel.

In the home loan sanction letter, banks say that the interest rate will change whenever the repo rate changes.

“If the existing borrower feels the rate charged is higher and the credit score has improved over the years after taking the loan, then they can approach the lending bank and apply for re-evaluation of the collateral risk and credit score,” said the spokesperson of a private bank, requesting anonymity.

After re-evaluating the profile, the bank will decide whether it wants to offer the borrower a lower rate.

When should you consider refinancing?

Often, the interest paid on a loan is the biggest component of the cost of home ownership. A loan cheaper by 50 bps or more could lead to a shorter tenure, lower EMIs, and more savings.

“An improvement in your credit score (750 or above) as well as income stability will allow you to access the best loan offers and a scope to negotiate with your existing lender,” said Patel.

He added that one must apply for refinance with a competitive bank and see the interest rates offered to you. Then go with the offer to your existing lender for negotiation on interest rates. If nothing works, then refinance your home loan.

Refinancing early in your loan tenor—typically in the first half—makes more sense because your EMIs at this stage consist largely of interest payments.

“Therefore, a lower interest rate will lead to big savings,” said Shetty.