Many players are entering the home loan market with promotional offers, which may be a good opportunity for existing borrowers to relook at their loans.
One should view home loans not as liabilities but as investments that need to be revisited time and again.
Jacob John had taken a Rs 20 lakh (Rs 2 million) loan from a leading housing finance company at 8 per cent in September 2003. At the time, the prime lending rate was 9.25 per cent and floating rate loans were being offered at a lower spread of 1.25 per cent.
The housing finance company today has not dropped its PLR, but has increased the spread against which it lends to 1.75 per cent.
This means that a new customer would effectively get a floating rate loan at 7.5 per cent, while Jacob continues to pay his equated monthly instalment at 8 per cent.
The scenario can be compared to one buying a durable such as a refrigerator.
Mr X could have bought a fridge for Rs 25,000 last May, and if the company is now offering a discount of Rs 2,500 it does not mean Mr X can demand the differential as a refund from the dealer.
While in the case of durables one cannot get the benefit of lower prices, one can do so in the case of home loans.
Many home loan firms are willing to convert old loans at revised rate of interest as applicable to promotional schemes. Of course, there is no free lunch and this will come at a conversion fee of 0.5 per cent of the loan outstanding.
Incidentally, though the conversion fee seems to be lower than that of the refinancing cost of 2 per cent, the benefit by refinancing the loan would be much higher from 3rd year onwards, assuming that on refinance the rate applicable is 7.25 per cent, while on conversion the rate is 7.75 per cent.
The benefit up to a two-year period is almost the same except the fee element on refinance, which is negligible on a Rs 20-lakh loan, as most players have a cap on the fees.
Jacob, for instance, wanted to continue with the Rs 20-lakh loan, and spoke to his existing housing finance company.
The company offered to convert the loan to a rate of 7.75 per cent. This would be at a one-time cost of Rs 10,000, taking the conversion charge of 0.5 per cent on the loan amount.
Jacob will be able to recover the benefit of a lower rate of interest in a span of two years. That means, taking into account the one-time conversion cost of Rs 10,000, from the third year onwards, he would be saving on his EMI.
However, should he pre-pay the loan in less than two years, then he would fail to benefit from the conversion.
At the same time, take the example of Jacob's neighbour, who was looking at Housing Development Finance Corporation's existing special promotional offer of 7.25 per cent on floating rate loans.
He had earlier taken a floating rate loan from another company at 8.25 per cent. Should he decide to opt for refinancing his loan, it would mean a straight saving of one percentage point.
Hence, on his Rs 20-lakh loan, even by paying the refinancing charge of 2 per cent -- which is the industry norm today -- he would see a saving after two years of his going to HDFC.
This is because he would be able to recover the refinance cost of Rs 40,000 from the third year onwards, as he is saving 1 per cent. However, should he pre-pay the loan in less than two years, then he would tend to lose from the balance transfer.
Clearly, paying a conversion charge or a refinancing penalty does in many cases work out beneficial for home loan customers. However, much depends upon whether the customer intends to continue with home loan over a longer period.
Today, the average repayment term of loans is about 7 years. Many prepay existing loans to go for fresh ones as they buy new homes, largely attributed to lifestyle, or change in jobs.
But a word of caution. Interest rates should not be the sole factor for switching to another home loan firm. Ultimately, it is the confidence and trust that an individual shares with his institution that really counts.
