Options in home loans

Representational Image [Source: Pixabay/ Hassan]

Most of the times, I receive emails from the readers seeking details of various loan schemes. Most of the queries are regarding housing loan segment where readers show their appetite for obtaining a housing/home loan. But lack of proper guidance and ‘cumbersome’ process stops them to pursue it. There are many who want clarity on interest rates as they have ‘heard’ stories of dispute over interest rate applied on home loans ‘in contravention’ to the basic loan agreement between the banks and the borrowers. They are irked by the ‘arbitrary’ change in their equated monthly installment (EMI) which is driven by change in interest rates during the tenure of the loan.

What we find is that banks don’t bother to educate their borrowers about the mechanism of applying interest rates on their home loans. They don’t even bother to inform them about the change in their EMI and this has been one the causes of confrontation between the banks and the borrowers.

Today’s borrower has to be very smart. He needs to ask questions to the bank while applying for a loan. For example, If you are planning to take a home loan, you need to know that there are two options as far as interest rates are concerned. One, you can obtain loan on fixed rate. In this case, the bank gives you loan on a fixed interest rate for a particular period. Second option is floating rate, which means the interest rate on your loan will change depending on the interest rate cycle in the market.

We are witnessing a trend where more and more people especially the young ones want to have access to home loan. They are always on a look out for better deal. They curiously seek guidance about best deals in shopping home loans.

What are the basic things which you should consider before going for a home loan?

First of all you have to decide about quantum of finance you require. Do it by considering your monthly income, your age, other debts and financial commitments. You should even take into your job stability. Your loan amount should not make your repayment  challenging that may lead to debt trap.

After deciding your loan amount, you should decide about repayment period of the loan. When your loan tenure is for short period, your equated monthly installment (EMI) will be very high. Longer tenure is generally chosen to enhance the loan eligibility of borrower but remember longer the tenure greater is the cost of borrowing. If EMI for short term is not affordable and you want to pay off your loan as soon as possible, consider middle path for the period of 10 to 15 years.

Then it is important to consider interest rate. You can either consider fixed rate or fluctuating rate of interest. Fixed rate of interest remains fixed for the entire tenure of loan irrespective of change in interest. Floating rate can go up or down depending upon the market scenario. There is also a hybrid loan having a combination of fixed and floating loans. Borrower can lock a portion under fixed and leave the remaining under floating rate.

After availing the home loan facility, it’s important to go for insurance of your home loan (Home Loan Protection Plan) as well as the property which you have purchased or constructed out of the bank loan.  Home Loan Protection Plan (HLPP) is an insurance plan where insurance company settles any outstanding amount on the home loan with the bank in the event of death of the borrower. This way, a borrower can ensure that his/her family will not have to pay the outstanding loan amount after demise of the borrower. However, it is not mandatory to purchase home loan protection plans. Under property insurance, you purchase cover against risks to property/home due to earthquake, fire, flood, storm, theft etc.

What is home loan overdraft facility?

It is a smart alternative for prospective home loan borrowers to reduce overall interest cost. It’s worth mentioning that big ticket size home loans with repayment tenure of 20 years or more bear interest portion more than the principal amount. It’s here the borrowers can take route of ‘home loan overdraft facility’ to reduce the interest cost. The borrower has to opt for a home loan with an overdraft facility also termed as a ‘home loan interest saver or smart home loans’. Existing borrowers can also avail of this facility subject to the fact that their bank is providing this facility. However, they can consider transferring the loan to another bank offering this kind of overdraft facility.

The modus operandi of the scheme is that a borrower can deposit surplus funds in his home loan overdraft account, usually either in the form of a savings account or current account linked to the home loan. The surplus fund parked in this account acts like a prepayment against the outstanding principal, thereby reducing the overall interest cost of the home loan. The borrower has the flexibility to deposit and withdraw excess funds from the overdraft account as and when required.

Notably, availing home loan overdraft option can help a borrower to avoid prepayment penalty.

However, a borrower is not eligible to avail tax benefit for the surplus amount deposited in the home loan account. It’s also to be noted that banks offering a home loan with an overdraft facility will charge higher rate of interest as compared to a normal home loan.

The interest rate of a home loan with an overdraft facility is usually a notch higher than a regular home loan’s interest rate.

Experts advise to avail home loan overdrafts facility if you have surplus funds available with you.  Otherwise, this kind of overdraft facility won’t be the right choice as it would be available at a cost.

What is ‘home loan switching’ facility? How beneficial is it for the borrowers?

This is the mechanism where a borrower can transfer his home loan account from bank to bank to get rebate in interest on the loan. In simpler terms, a borrower is encouraged through some ‘concessions’ to take a new loan from another bank to repay his existing loan.

Borrowers using switching route is not bad, but there are certain riders which need to be evaluated before taking a flight on the route. For example, a borrower can take commanding position and ask his/her existing bank for re-pricing options, before actually switching his loan to other bank.

The decision to switch has to be based on more factors than just interest rate. It’s not free. As a borrower intending to avail switching service, you should first ask your current bank whether you will incur a fee for terminating your existing loan or you can convert the loan to one which is more attractively priced. Check if any fees will be imposed on such conversion. Before switching to the new bank whose refinancing package you are considering, check how you will be better off with the refinanced package.

One should note that the installment amounts and interest payments will change once there are changes to the loan package. Also, compare the present repayment schedule for your current loan package with that of the new loan package you are considering and check the total amount of interest payable and other charges.

After calculating the net impact, if you find the cost of switching higher than your savings after the transfer, then the switch does not make sense. It also needs to be taken into account that transfer costs are to be paid immediately, whereas your savings after the transfer will come to you over the years.

Technically speaking, loans with low outstanding amount and a few years of repayment remaining are not ideal for switching. The costs involved would be higher than the expected benefits.

And last, but not the least. Try to understand the ‘teaser offer’ meticulously. Check why the bank, where you want to switch your loan is offering a lower interest. Don’t rush into any hasty decision. Remember, the banks are locked into a stiff competition. Their profitability over the years has witnessed erosion. The only way to restore their profitability is through the business of loans. So, why would one want to give you loans at a lower interest rate and lose profits when others in the market are earning a higher rate of interest?