Banks cut lending rates: Here's why shifting home loans isn't cheap

If gains are spread over four-five years, it really does not make sense to switch

Whenever banks or housing finance companies (HFCs) cut interest rates, there is an immediate interest among existing borrowers who want to know if it is a good time to shift their home loans. With calendar year 2017 starting with significant rate cuts from leading banks and HFCs, many are excited as the new rates look quite different — 40 to 50 basis points (bps) lower — than their existing loan rates. 

Currently, State Bank of India (SBI)’s rate is the cheapest at 8.65 per cent for loans up to Rs 75 lakh. ICICI Bank and HDFC’s rates are 5 bps higher at 8.70 per cent. For higher-value loans it’s the same difference of 5 basis points (bps), with SBI at 8.70 per cent. 

On the other hand, many existing customers of SBI, who borrowed during the base rate regime — between July 1, 2010 and March 31, 2016 — could be paying an interest rate of 9.25 per cent. The benchmark of home loans was changed from base rate to marginal cost of fund-based lending rate (MCLR) from April 1, 2016.

Many of these customers might be looking to shift. “To retain customers, many lenders are willing to offer you interest rates 5-10 basis points higher than the lowest rate in the market for a small fee. In such a case, it would be worth staying with the existing lender,” says Rishi Mehra, co-founder of Deal4loans. But, most banks or HFCs would charge you to align your existing rate completely with the new rate. So, before you shift, do a proper cost-benefit analysis.

From base rate to MCLR: The charges could be higher when shifting from base rate to MCLR. Banks offer two options to borrowers — they either shift for free and continue on the same interest rates for a year or pay 0.5 per cent of the principal outstanding, or a minimum of Rs 10,000, to get the low interest rate benefit.

Say, you have borrowed Rs 50 lakh for a period of 20 years at the interest rate of 9.5 per cent and after two years, the rate has come down to nine per cent. The reduction in the equated monthly instalment (EMI) will be Rs 1,515 (See table). 

 

If you want to shift from the base rate mechanism to MCLR, there will be a cost of 0.5 or slightly more, depending on the bank. In other words, if the outstanding is say, Rs 45 lakh, you would incur a cost of Rs 22,500 for shifting. Is it worth it? If we consider the above-mentioned example, it would take almost two-and-a-half years to recoup the costs of shifting. 

In such a situation, it may still make sense. “The cost you pay should be recovered in two years. Just like an individual keeps track of investments; he also needs to keep evaluating long-term high-value loans every year or two and see if he can save cost by shifting,” says Naveen Kukreja, co-Founder and CEO, Paisabazaar. For a loan of over almost 20 years, you are likely to see many interest rate rises and declines. And unless cost of moving gets compensated quickly, say 12-24 months or slightly more, it may not really make sense to shift because you could be staring at another interest rate decline or even a rise which can reduce the benefits significantly. 

From one bank to another: If your outstanding is higher than Rs 45 lakh and you are still on base rate, it would be cheaper to shift lenders if the other one is offering same rates or lesser. The cheapest cost of shifting banks is Rs 21,500. This includes Rs 11,500 for processing fee and Rs 10,000 as legal and technical charges. So, it is important to weight the costs. Experts say that if the difference is 100 bps and the remaining tenure is five-eight years, it might still make sense. 

Strategy for high-value loans: Foreign and some private banks are aggressively promoting high-value loans — those above Rs 75 lakh. If you meet their eligibility criteria, they are also willing give rates that are close to the lowest interest rate in the market. A direct selling agent says that many wealthy clients ask the new lender for a top-up loan along with balance transfer while keeping the EMI and tenure unchanged. This way, they get a cheap top-up loan as well. For example: Say, a borrower takes Rs 1 crore loan at 9.5 per cent interest rates for 20 years. The EMI will be Rs 93,213. After completing five years, he decides to shift. The outstanding principal works out to Rs 86.44 lakh. If he takes a new loan at 8.7 per cent for 15 years on the outstanding principal, the EMI works out to be Rs 86,136. But if he keeps the EMI and tenure constant, he is eligible for Rs 7 lakh top-up loan.