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The Art of Re-Financing

 

 

Interest rates have finally cooled off a bit, with the RBI bringing down the CRR and repo rates recently. Some banks have already announced rate cuts on loans and few others are following suit. So, does it make sense to refinance your existing home loan? Will it help you save significant money by closing your high cost home loan and shifting to another bank that gives a lower interest rate?

I had taken a home loan of Rs 9 lakh from ICICI bank in November 2004, at a 7 per cent floating interest rate for 20 years. Since then, interest rates have gone up considerably. Now, my Equated Monthly Instalment (EMI) has also increased and I have a remaining tenure of 23 years. I am planning to shift my loan to State Bank of India (SBI). They have offered almost the same EMI and for a 15 year tenure. Should I shift?

– Tanmay Shastri

Yes, it makes money sense to take up SBI’s offer. Here’s why:

You save time and money

1. Your remaining tenure with ICICI is 23 years and SBI is offering you a 15-year tenure (with EMIs being the same). By switching lenders, you will reduce your tenure by a good eight years! In other words, you have 96 fewer EMIs to pay back.

2. With a reduced tenure, you would also save money (and a significant amount at that), despite the loan foreclosure fee of around 2.5 per cent that you will pay ICICI and the loan-processing fee of around 0.5 per cent that you will pay your new lender, SBI.

How much will you save? Rs 8.17 lakh!

Let’s do some number crunching to see how.

In 2004, the interest rate was 7 per cent and in 2008, its around 12 per cent, hence, the average interest rate is around 9 per cent. So, the approximate principal amount you would have paid in the last four years would be around Rs 70,000. This leaves us with Rs 8.30 lakh as the loan amount that SBI will lend you.

Let’s compare the total EMI you will pay under both cases, that is, SBI and ICICI, to see your net savings on the loan.

Bank Loan tenure (in years) Loan amount (in Rs lakh) Interest rate (in per cent)* Total EMI (in Rs lakh)
SBI 15 8.30 10 16.05
ICICI 23 8.30 12 24.47
 

*Approximate floating interest rate charged by the two lenders presently.

– Total outflow if you continue with ICICI (A) = Rs 24.47 lakh

– Total outflow if you switch to SBI (B) = Rs 16.30 lakh*

*This is the Total EMI to SBI + processing fee (to SBI) + loan foreclosure fee (to ICICI).

(Total EMI to SBI = Rs 16.05 lakh

Processing fee = 0.5 per cent x Rs 8.30 lakh = Rs 4,150

Loan foreclosure fee = Rs 8.30 lakh x 2.5 per cent = Rs 20,750

Total outflow = Rs 16.05 lakh + Rs 4,150 + Rs 20,750 = Rs 16.30 lakh)

– Net savings from the switch = (A) - (B), that is, Rs 24.47 lakh minus Rs 16.30 lakh = Rs 8.17 lakh

Why is SBI giving a lower cost loan?

It has managed to keep its borrowing costs low and hence, is able to provide attractive interest rates as compared to ICICI.

The recent CRR and repo rate cuts gave SBI further advantage and it slashed its loan rates.

As you had taken on a floating rate with ICICI and the SBI offer is significantly lower, it is unlikely that it will go as high as ICICI’s current interest rate.

Switch your way into a low cost loan

– When interest rates increase, either loan tenure or EMI (or both in some cases) go up. See if another lender offers you a considerably lower EMI or tenure, with other aspects being more or less constant. If yes, then you stand to gain with a switch.

– Find out if you can bargain for a waiver in processing fees with the new lender or in foreclosure fees with the earlier lender.

 

Source: Bank Bazar

By vayaM CS