Source: The economic Times.
Home loan borrowers have more reasons to worry. As a consequence of the recent hike in the cash reserve ratio (CRR), banks have yet again hiked the home loan rates. Higher rates are not only increasing the cost of home acquisition, higher EMIs are also putting tremendous pressure on monthly budgets. In such a scenario, the loan taker has three main options - pre-pay a part/whole of the loan, switch to a fixed-rate loan, or opt for an increase in tenure. We explore each of these three options.
Prepayment of loan
The fundamental question is whether it is wise to prepay even at this time. "You can prepay the loan provided you have investments profits from equity or additional surplus after meeting all commitments," says a certified financial planner and a chartered wealth manager Kartik Jhaveri. Industry experts say that a borrower should not prepay the loan with the only intention of keeping the EMI constant. Usually, with the incremental income , borrowers can absorb the rise in EMIs. What a borrower should calculate is the optimum EMI he can service with a possible rise in the salary. Says UTI Bank's head-retail assets, Sujan Sinha, "Every borrower is comfortable with a certain amount of deduction. So, a borrower can partly prepay the outstanding loan amount such that the interest and the principal outgo remain unchanged."
When should you prepay the loan? - This decision can be tricky too. While prepaying principal reduces the liability and the cumulative interest one will pay, it can also reduce the ability to take full advantage of the tax benefits on home loan interest. So, if you want to control your overall absolute cost of acquisition, prepayment in the initial stages can be fine as maximum interest is chargeable then. However, if it is advantageous to claim full tax benefits, it may be better to stick around till the later stages of the loan. That is the time when interest component in an EMI is low and principal is the dominant component. "Let's assume you have borrowed Rs 30 lakh for 15 years. The total pay out for the first year aggregates to over Rs 4 lakh, principal accounts for almost Rs 76,000 of this outgo. In the last quarter of the loan (after 10 years), the outstanding principal is over Rs 16 lakh. Now, if you partly/wholly prepay the loan you stand to gain from better tax benefits as interest outgoes are substantially lesser in this cycle of the loan" says VP UTI Bank retail assets VP Sujan Sinha.
How do you finance your prepayment? - If you get some bonus or are sitting on surplus cash, you can partly prepay the loan. This would help you keep the EMI and the tenure of the loan constant. You can avail of an overdraft facility against NSC, LIC policy or shares to offset the increase in EMIs/tenure. However, it does not make sense for a borrower to break into his liquidity to prepay the loan. For example , a borrower can invest the same amount in a tax saver fixed deposit to earn a higher return. A borrower should calculate internal rate of returns and calculate other options before arriving at a decision.
Conditions for part prepayment - You can partly prepay your home loan only under certain conditions . For instance, HDFC allows to prepay only twice a year, provided your amount is at least three times the EMI. SBI is slightly stringent. It doesn't allow you to prepay more than 50% in the first five years. If you intend prepaying your loan, then it would make sense to go for a floating rate as most banks or financial institutions do not charge prepayment charges for floating rate loans. Fixed loans, however, normally carry prepayment charges of 2%.
Fixed vs floating
Industry experts recommend floating rate for new customers. "A floating rate product comes at a rate of 11-12 %. However, a true fixed product, which is not linked to money market conditions (MMC), comes at nothing less than 13-14 %. Now, if you borrow a home loan at a floating rate of 11%, it will take at least a year or two for a floating rate to increase. In these two years, a borrower will save a considerable amount by riding on the lower end of the interest rate cycle," explains Apnaloan CEO Harsh Roongta.
Should the existing floating customers switch to fixed product? - It does not make any financial sense for borrowers to switch from floating rates to fixed rates or vice versa. Industry experts estimate the average growth of income of salaried employees at 20% in 2006-07 . In the same period, the EMIs grew by almost 25%. The difference is reasonable and borrowers can cope with the rise in EMIs. If you want to convert to fixed rate then you have to pay 1.75% as conversion charges on the principal outstanding amount (charges are for ICICI Bank and HDFC). Nationalised banks charge up to 2%.
Increase EMI or tenure
Whenever a bank/HFC increases the interest rate, a borrower witnesses a hike in either the EMIs or tenure. If you stick to EMI, a half a percentage point increase in borrowing rates could increase your tenure by 25 months. Which one is a better option? - "If you can adjust your monthly budget, bear the increase in EMIs. Try not to increase the tenure of the loan as it would increase the overall cost of the house," adds Mr Roongta. However, if you choose to increase the tenure to keep the EMI constant, banks can do so only up to a point. Beyond that, if the interest rate continues to rise, the EMI becomes insufficient to cover the loan (interest and principal) and banks are forced to increase the amount of EMI as well.
WHAT NEXT?
Home loan borrowers have more reasons to worry. As a consequence of the recent hike in the cash reserve ratio (CRR), banks have yet again hiked the home loan rates. Higher rates are not only increasing the cost of home acquisition, higher EMIs are also putting tremendous pressure on monthly budgets. In such a scenario, the loan taker has three main options - pre-pay a part/whole of the loan, switch to a fixed-rate loan, or opt for an increase in tenure. We explore each of these three options.
Prepayment of loan
The fundamental question is whether it is wise to prepay even at this time. "You can prepay the loan provided you have investments profits from equity or additional surplus after meeting all commitments," says a certified financial planner and a chartered wealth manager Kartik Jhaveri. Industry experts say that a borrower should not prepay the loan with the only intention of keeping the EMI constant. Usually, with the incremental income , borrowers can absorb the rise in EMIs. What a borrower should calculate is the optimum EMI he can service with a possible rise in the salary. Says UTI Bank's head-retail assets, Sujan Sinha, "Every borrower is comfortable with a certain amount of deduction. So, a borrower can partly prepay the outstanding loan amount such that the interest and the principal outgo remain unchanged."
When should you prepay the loan? - This decision can be tricky too. While prepaying principal reduces the liability and the cumulative interest one will pay, it can also reduce the ability to take full advantage of the tax benefits on home loan interest. So, if you want to control your overall absolute cost of acquisition, prepayment in the initial stages can be fine as maximum interest is chargeable then. However, if it is advantageous to claim full tax benefits, it may be better to stick around till the later stages of the loan. That is the time when interest component in an EMI is low and principal is the dominant component. "Let's assume you have borrowed Rs 30 lakh for 15 years. The total pay out for the first year aggregates to over Rs 4 lakh, principal accounts for almost Rs 76,000 of this outgo. In the last quarter of the loan (after 10 years), the outstanding principal is over Rs 16 lakh. Now, if you partly/wholly prepay the loan you stand to gain from better tax benefits as interest outgoes are substantially lesser in this cycle of the loan" says VP UTI Bank retail assets VP Sujan Sinha.
How do you finance your prepayment? - If you get some bonus or are sitting on surplus cash, you can partly prepay the loan. This would help you keep the EMI and the tenure of the loan constant. You can avail of an overdraft facility against NSC, LIC policy or shares to offset the increase in EMIs/tenure. However, it does not make sense for a borrower to break into his liquidity to prepay the loan. For example , a borrower can invest the same amount in a tax saver fixed deposit to earn a higher return. A borrower should calculate internal rate of returns and calculate other options before arriving at a decision.
Conditions for part prepayment - You can partly prepay your home loan only under certain conditions . For instance, HDFC allows to prepay only twice a year, provided your amount is at least three times the EMI. SBI is slightly stringent. It doesn't allow you to prepay more than 50% in the first five years. If you intend prepaying your loan, then it would make sense to go for a floating rate as most banks or financial institutions do not charge prepayment charges for floating rate loans. Fixed loans, however, normally carry prepayment charges of 2%.
Fixed vs floating
Industry experts recommend floating rate for new customers. "A floating rate product comes at a rate of 11-12 %. However, a true fixed product, which is not linked to money market conditions (MMC), comes at nothing less than 13-14 %. Now, if you borrow a home loan at a floating rate of 11%, it will take at least a year or two for a floating rate to increase. In these two years, a borrower will save a considerable amount by riding on the lower end of the interest rate cycle," explains Apnaloan CEO Harsh Roongta.
Should the existing floating customers switch to fixed product? - It does not make any financial sense for borrowers to switch from floating rates to fixed rates or vice versa. Industry experts estimate the average growth of income of salaried employees at 20% in 2006-07 . In the same period, the EMIs grew by almost 25%. The difference is reasonable and borrowers can cope with the rise in EMIs. If you want to convert to fixed rate then you have to pay 1.75% as conversion charges on the principal outstanding amount (charges are for ICICI Bank and HDFC). Nationalised banks charge up to 2%.
Increase EMI or tenure
Whenever a bank/HFC increases the interest rate, a borrower witnesses a hike in either the EMIs or tenure. If you stick to EMI, a half a percentage point increase in borrowing rates could increase your tenure by 25 months. Which one is a better option? - "If you can adjust your monthly budget, bear the increase in EMIs. Try not to increase the tenure of the loan as it would increase the overall cost of the house," adds Mr Roongta. However, if you choose to increase the tenure to keep the EMI constant, banks can do so only up to a point. Beyond that, if the interest rate continues to rise, the EMI becomes insufficient to cover the loan (interest and principal) and banks are forced to increase the amount of EMI as well.
WHAT NEXT?
- If you get some bonus or are sitting on surplus cash, you can partly prepay the loan.
- A borrower should calculate internal rate of returns and calculate other options before arriving at a decision.
- Most banks or financial institutions do not charge prepayment charges for floating rate loans.
- Try not to increase the tenure of loan as it would increase the overall cost of the house.
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