Home Loan Restructuring ( Article first was published in Mar 2022)
As We are aware that RBI has increased repo rate by 0.4% recently. Repo rate is the rate at which RBI lends money to financial institutions.
This increase will obviously impact home loan rates in near future and as rates rise, home loan tenures will get longer and interest outgo will be higher.
I am just illustrating herewith what measures one can take if home loan rates increase in near future.
Let’s say you have a home loan for 20 years (240 months) @ 6.5%. Interest outgo for every lakh of loan is Rs 78937/- and EMI/month/Lakh is Rs 745.57/-
Let’s say the home loan rate increase to 7%. Interest outgo for every lakh of loan will be Rs 87000/- with EMI/Month/Lakh capped to Rs 745.57/- though tenure of loan increased to 262 months.
To soften the burden of rising interest there are 2 broad options, one to get lower rate on your loan or to prepay.
- Refinance loan
Refinancing means taking a fresh loan at lower rates than proposed increased home loan rate.
This works when there is a sizeable difference at least 25 basis points between current rate and refinanced rate.
If one is able to negotiate lower rate (at least 25 basis points) then instead of taking a lower EMI it is better to keep paying original EMI and close the loan faster.
Let’s say one is able to negotiate to 6.75% for 20 years for Rs 1 lakh loan. Your interest reduces to Rs 82487/- which means appx Rs 4500 Rs saving against every lakh of loan. You may deduct the processing charges for the new loan but still the refinanced loan rate will be beneficial to the buyer; for e,g, for a Rs 30 Lakh loan balance –it will be beneficial to the tune of appx 1.1 lakh rs net of processing charges of apx Rs 25000 for the new refinanced loan .
When you refinance to a lower rate pls keep paying your original EMI which will close the loan faster.
- Prepay the loan
As per the Financial experts prepaying 5% of the reducing balance every year is the optimal prepayment.
Pre-paying 5% of the balance at the start of every loan year will help pay off a 20-year loan in 12 years.
Regular Pre-payments also will act as cushion against rate hike.
So, the rate hike will add EMIs to the loan and pre-payments will reduce them.
For best results one can use all the options judiciously –refinance to a lower rate, pay higher EMI/month and pre-pay 5% every year.
