If you are an existing home loan borrower then I am sure you must be experiencing the interest rate fluctuation in the market which is impacting your home loan outstanding. Any announcement from RBI, may results in either EMI goes up or tenure increases. Over a period of time the spread between the current prevailing interest rate (Market Rate) on home loans and your existing interest rate becomes wide.
Every home loan borrower can avail the option to switch into a lower interest rate by opting for conversion or change of spread for the existing loan which may be at a higher rate. By changing the interest spread on the loan, one can get the lower interest rate being provided to new borrowers. You as a borrower have the option to choose between increased the EMI or keep it same so that the loan tenure will get reduced automatically. However increased EMI ensures faster repayment than keeping it constant. Borrower can also look at increasing the tenure by reducing the EMI, but this seems to be not a good idea.
First you need to do your monthly cash flow planning, then opt for whether EMI should be increased or let it go as it is and get the benefits of lower interest rate on repayment which eventually adds more towards your outstanding principal amount.
Generally lenders (Banks & HFCs) do not communicate their existing borrowers about the option if the rates are fallen down and the delta or spread if considerably high between your current rate and bank’s current offerings. But remember, conversion of home loan is chargeable at certain percentage on outstanding loan amount or on the spread/delta of the rate you are paying and the market rate, which depends on Banks or HFCs respectively. Normally conversion fee ranges between 0.50%-1%. So you need to do your mathematics first before you decide to take the plunge. If you see there is considerable amount of interest may get saved over a period of time then such conversion is worth taking, else better be in current plan.
How does it work?
Let us understand with example how the conversion of home loan works.
For example : Mr. Ranjan took a home loan of Rs. 35,00,000 few years back say July 1, 2006 for 20 years with the interest rate of 10.5% floating rate. Due to increase in base rate of bank, his loan interest has reached to 14%. He approaches to his bank to reduce the interest rate where new borrower is getting it at 10%.
Now let’s calculate the conversion cost for Mr. Ranjan where the total outstanding is at Rs. 29,00,000 (assume till date he repaid Rs. 6,00,000 principal). As the current new offering from bank is 10%, therefore the spread is of 4% between current rate and existing rate which is being paid by Mr. Ranjan.
Outstanding Loan = Rs. 29,00,000
Current Rate of home loan for Mr. Ranjan = 14%
Current Market Rate for new Customer = 10%
Conversion Fee = 0.50% (calculation based on interest rate spread)
Therefore Loan Conversion Fee = Rs. 58,000 i.e. Rs. 29,00,000 × [0.50%× (14%-10%)]
Now if you spread this Rs. 58,000 in rest of loan tenure i.e 14 years (20 years – 7 years) it comes Rs. 4,142.86 per year where you are able to save Rs. 9,667 i.e. (Rs. 29,00,000 × 4%/12) as interest in month due to difference in interest rate of 4% from old rate to new rate.
With this lower rate of interest if he keeps on paying the same EMIs then he will be able to repay the loan in approx 27 month in advance.
Let us look into a detailed analysis how interest rate reduction helps you in repaying the loan much in advance than decided tenure and how much interest can be saved with such conversion.
The actual scenarios can be little complex because every time interest rates come down, the old home loan borrowers will continue to pay a higher rate unless the bank lowers the base rate. And it won’t be possible for them to go through the same exercise of converting rates after every reduction.
As you can very well see with a rate reduction from 12.00% pa to 10.50% there is a potential savings of Rs. 19,25,130 and Rs. 10,83,938 for 20 years and 15 years of tenure respectively. Even it is quite visible that a lower interest rate also helped in repaying the outstanding amount before the specified periods. Look at the below table which shows how your repayment tenure reduces if there is any cut in the current rate structure keeping the EMI same.
Converting the loan in lower rate with existing lender is quite simple and hassle free because it does not require much of documentation because all the documents are there with them.
Who should opt?
- The borrower who’s left over tenure is large. If the tenure is short the interest part anyways will be less towards repayment of home loan so the complete benefit will not be lucrative.
- If the spread between the current rate for new customer and existing customer is high. It’s better if the spread is more than 1%.
- If current EMI is quite high which is becoming burden to manage the monthly household expenses.
- If you think that the rate will not fall below from here.
“This benefit is only available for aware borrowers”. This means, many a times bank never come up on their own and offers you such option, so it’s better you ask for it.
What other points to be noted:
- Once you finalise to go for a conversation option you need to sign the request letter and submit at the nearest bank. Also make sure all the applicants are signing the application in case of joint loan.
- If you go for increase in the monthly installment and the mode of payment is post-dated cheques, then fresh EMI cheques will have to be submitted.
- Be aware about the conversion fees, which is usually in the range of 0.5%-1% of the loan amount. This has to be paid through a cheque issued at the time of submitting the documents. Sometimes this can be negotiated, so ask for it.
- In case you don’t find conversion option feasible then look for other option like making additional repayments (part payments) which will save your interest and help you pay off your loan quicker.