Monday, 30 April 2012

Should You Shift To Lower Interest Rates? - Home Loan

graur cordin
My Friend Aakash met me over weekend. Aakash in 2009 had taken a home loan from reputed bank. The loan amount was 50 lakh @ 9 %(floating) - Tenure 15 Years. As the name suggests the floating interest kept on floating higher and higher. 51K was the initial EMI; every now and then the banks increased the interest rate and accordingly re-priced the EMI. Interest rate changed from 9% to 12% and so did EMI change from 51k to 60k.
Thanks to RBI for bringing an end to the high interest regime.  This news gave Aakash a big relief.  He called up the bank to check if the bank was planning to reduce the interest rates. The executive was quick to respond and said “Yes the Bank is indeed planning to reduce interest rates, however the reduced rate of interest was applicable only to new customer”. He further continued, in case you wish to shift to lower interest rates, you need to pay one time processing fees of 1% of outstanding. 45 Lakh is the outstanding amount, this means Aakash needs to pay 45K to shift or reduce his interest rates.
Aakash was upset over this and asked the banker, what kind of processing fees?  I have opted for floating interest, if it can go up on its own, why does it need special processing when it has to come down? The bank guy replied, sir this is the policy, to avail the reduced interest, you need to pay the processing fees.
Let’s get out of the policies and look into some simple Math.
With 13 Years to Go, Aakash will be paying 44 Lakh towards interest if his loan continues at 12%. On the other hand if he agrees to pay the processing fees of 45K, his interest rate will be re-set to 10.75%. By doing this, Aakash will end up paying 39Lakh interest instead of 44Lakh.
Take Away: Aakash will save around 5 Lakh in the form of interest over the balance period of 13 years.
Let us quickly see if it makes sense to shift the loan to new bank:
Well the answer is not simple, one needs to factor in various costs. The interest rate being charged by the new bank, the processing fees, advocate fees, Stamp duty for loan papers etc. In addition to this you will have to dedicate your time, till the loan is taken over.
Unless there is substantial difference in savings, shifting to new banker makes no sense.
What would be your suggestion to Aakash?


Is It Possible said...

A quick look suggest that it would still help Aakash to switch, why?

He is stuck in the floating interest contract and unless bank puts a FULL STOP, he is still prone to increase in rate. Lets assume bank stops his rate at current 12% then his best bet is to negotiate the rate with current bank or shop for better rates outside. If the difference of current vs new is significant (relative to everyone) then he is better of reducing his rate and enjoy the savings...

WealthUCreate said...

Shopping for Better rate outside makes sense if the savings is substantial. If the difference in negotiating and shifting is less than 50K over a period of time, then i feel staying with bank makes sense.
You need to factor in the time you would be spending to hunt for new banker and activites involved in loan processing.

Stacy Barbee said...

Private mortgage insurance or PMI enables you obtain more money as home loan. The reduction in the FHA refinance rates will surely help those homeowners who are behind on their mortgage payments.

Anonymous said...

How about if interest rate increase again? in coming days / years. It will again increase the EMI.
Then what will be other options?

WealthUCreate said...

Rising interest is out of our control. To some extent you are saved, if you are in some teaser loans or fixed interest.

The best option is to make regular partpayment and get out of the loan ASAP. You should shift your loan to other bank only when there is substantial saving. Make sure you factor in the time that you are spending or devoting in this process.

Anonymous said...

need to check spread rate

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