We can make a proper assessment only when we know all the additional charges
Borrowers with home loans have a new reason to be a little bit happy in these stressful circumstances. Most lenders have been reducing their home loan rates to new multi-year lows. Naturally, the existing borrowers wish to benefit from the falling rates.
And why shouldn’t they? After all, home loans are usually the largest for most people. So, if the interest rate on home loans is reduced, then it can lead to substantial savings on interest outgo.
Existing borrowers can get the benefit of lower rates by switching their ongoing loans. But you must be cautious and not just go for the switch because of the interest rate differential alone. One needs to do a bit of cost-benefit analysis to see whether it makes sense to make the switch or not.
But if it’s not just about the interest rate differential, then what else should a borrower consider?
Pre-payment charges of the old loan, processing fee the new loan, stamp duty charges (on the new lender’s mortgage document), legal/technical fee, etc. can make a considerable difference by adding layers of additional cost that a borrower will incur while switching.
There is no denying that even a small reduction in loan rates can mean savings for the borrower. But if the additional costs nullify that benefit from lower rates, then the very purpose of the loan switch stands defeated.
So when should one switch and when one shouldn’t?
Ideally, the calculations should be done on a case-to-case basis. One more aspect to consider is the outstanding loan tenure. And to be fair, we can make a proper assessment only when we know all the (additional) charges involved in addition to the interest rate differential.
Criteria for changing lenders
But considering everything, it makes sense to shift your home loan only if there is a difference of at least 50 basis points between the new and old rates and the remaining tenure is at least 10-plus years. For loans where the tenure left is less than 10 years, the interest difference should be much more than 50 basis points.
So, in general, lower new loan rates are better for you. But the remaining loan tenure also plays a bit of a role in the decision.
That is, the greater the remaining loan tenure, the more will be the potential benefit from interest savings. And that is because when only a few years have passed, a large portion of the home loan principal is still outstanding due to the nature of how loans work.
If you switch to a lower home loan rate, then obviously your interest component of EMIs will reduce. And so will (to a small extent) the tax benefit eligible for interest deduction under Section 24. But that’s an acceptable side effect for most.
It might also make sense to check your credit score yourself before approaching new lenders for switching. That way, you can use this data point to first try and renegotiate a lower rate with your existing lender. If that doesn’t work, then you can approach other lenders and in that case too, you will be in a good position to negotiate a better (lower) rate if your credit track record (score) is good enough.
Also, before making the switch, check the home loan rate track record of the new lenders as many of them provide short-term offers to attract existing borrowers initially. And then, later on, the benefit doesn’t get passed on at an acceptable pace.
But for those who wish to prepay their home loans quickly and in the next few years, it generally doesn’t make much sense to switch the loan when you consider all the additional costs and hassles involved.
These days, no doubt the home loan rates are at multi-year lows. But many borrowers are experiencing some delays while switching due to lockdown-related operational issues. So the processing of loan switches has become a bit slow temporarily.So all said and done, don’t just blindly apply for loan transfer by only considering the interest rate differential and without weighing all other factors. Do a cost-benefit analysis considering the outstanding home loan principal, the remaining loan tenor and additional costs of switching. It’s possible that after analyzing everything, it might still not make sense to switch the loan in spite of interest differential.