When Idea Cellular General Manager Tejasvi Bishnoi finally shortlisted a house on the outskirts of Mumbai, his next task was to identify the loan product that would finance his dream home. His requirement: Rs 70-85 lakh.
Soon, Bishnoi was inundated with home loan offers. Among the many offers that he has, one is an offset home loan. This loan allows the borrower to save and, at the same time, utilises the savings to reduce the interest payable on the loan. At present, an offset home loan is offered through HSBC’s Smart Home Loan, Standard Chartered’s Home Saver and Citibank’s Home Credit loans.
Typically, in this loan, one has to open a current account with the bank and maintain a specific amount as balance. The interest is charged after reducing the principal by the balance amount. The balance amount can go up or down, depending on one’s cash requirement. As a result, while the equated monthly instalment (EMIs) will not change, the interest component will keep on fluctuating. This can make a big difference, especially if there is a high balance maintained in the initial years, because the interest component accounts for a major chunk in EMIs.
Take Bishnoi’s example. If he borrows Rs 80 lakh for 20 years at a rate of 9.5 per cent, the EMI would be Rs 65,249. In this case, the interest component is Rs 55,417 in the first month and the principal is Rs 9,833.
If he maintains a balance of Rs 3 lakh in his current account, his outstanding will be reduced by that extent and the rate of interest will be on the balance Rs 77 lakh in the first month. This will mean a lower interest payout. As Apnapaisa.com CEO Harsh Roongta puts it: “This amount helps you save the interest payable. So, a penny saved will be a penny earned in this case.”
Since the current account balance is likely to fluctuate, the rate of interest is calculated on a daily basis in an offset home loan. Hence, if you maintain a current account balance of Rs 3 lakh for 20 days and Rs 2 lakh for 10 days in a month, the interest payable will be calculated on Rs 77 lakh for 20 days and Rs 78 lakh for 10 days.
As the bank is likely to earn a lower interest income in this model, the rate of interest on an offset home loan is usually higher by 25-50 basis points. Also, the idle cash in the current account does not earn any interest. If this cash was deposited in a bank account, it would earn an interest rate of 3.5 per cent annually. If it were to be invested in other instruments, the rate of return could be much higher.
Financial planners feel these loans are best suited for businessmen rather than salaried individuals. “Businessmen are more likely to have high cash-at-hand and temporary surplus quite often. And, since the interest is calculated on a daily basis, even if surplus funds are deposited in the account for a single day, it can reduce your interest,” says certified financial planner Gaurav Mashruwala .
This is quite unlike a salaried person who gets his pay packet at the start of the month, and his bank balance is likely to keep on reducing during the month because of expenses. Such a loan requires very high discipline in terms of maintaining the balance in the current account consistently for long periods, for best results.
For someone like Bishnoi, a regular home loan is preferable. The surplus, if any, can be invested in the stock market or mutual funds for earning returns. And, the returns can always be used to prepay the loan.
