In the real estate euphoria,
buying a property must be figuring on your shopping list amid high inflation.
While home loan rates are sure to remain hovering as the central bank tightens
liquidity in the system. In this scenario, taking home loan is not arduous but
also become a big task in itself and one of the biggest financial decisions. At
that moment, the period of 10-20 yrs, demands a long term commitment.
After engaging with your home loan, each month
you have to pay your EMI comprises with principal and interest component. You
have ever seen that, as the RBI increases rates, your bank also raises your
interest rate. Subsequently, let’s say
it is charging 12.5% pa but is offering new customers much lower rates of 10.25%-10.50%
pa. In another aspect, despite paying
higher EMI every month for two years, your outstanding balance is still continued
to remain high. Such outbursts by people who have already been taken home loan
feel ‘cheated’ by such anomalies. There are numerous things to be done while
taking the home loan and after taking the home loan; hence you should know
about your home loan myths and truths which are the surest way to avoid tiffs
with lenders and even after that. Read also:How Banks fooling Home Loan Customer?
1.
Old Customers are charged higher interest rates than new Customer
Before July, 2010, banks used
PLR (Prime Lending Rate) to offer their most creditworthy retail customers
which was too much higher than subsiding corporate customers. Then, RBI
introduced the base rate system in which banks can not lend below that rate.
Ever since, all loans by banks are linked to their base rates. Banks arrive at
the base rate after looking their cost of funds and other factors. Their base
rates are kept under review at least once a quarter, floating rates may go up
or down based on the call taken by each bank. That is why; each bank has
different interest rates.
Your interest rate is usually
set on base rate plus margin, for example, if the base rate is 10% and its
margin 50 basis points or bps, then bank would charge you interest rate 10.50%
from your home loan. The base rate may change but the bank cannot alter the
spread or the margin at which it has offered loans to existing customers. So,
if the base rate comes down from 10% to 9.75%, the interest for existing
customers will fall from 10.50% to 10.25% while considering a spread of 50 bps.
However, banks can offer new loans at a higher or lower margin, say base rate
plus 25 bps. So for a new customer, the rate will be @ 10% (base rate 9.75%
plus 25 bps) while old customers will remain continued to pay @ 10.25%.
However, those differential rates may happen with a few lenders but is not a
general practice. Actually, it depends upon the price methodology followed by
individual lenders.
2.
Initially your Outstanding Principal reduces at a very Slow pace
It does not matter how high or
low your EMI and being paid on your loan, its interest component will remain
very high in the initial years due to the higher rate of interest or longer
loan tenure.
Let us consider that you have
taken a loan of Rs40 lakh for 20 years at an interest rate of 10%. Your EMI
will be Rs38,600. After two years, the outstanding principal will be Rs38.60
lakh. For Rs9.26 lakh that you have paid in these two years, the principal will
fall by paltry sum of only Rs1.40 lakh. In the first five years, only 17.6% EMI
will go towards paying the principal. In the first 10 and 15 years, only 23%
and 31.5% EMIs respectively, will go towards payment of the principal.
You will see that the reduction
in principal is very much slower than interest component in the first few
years. That is why; it makes sense to prepay the loan during initial years
instead of later years. Read also: Home Loans beyond Repayment Capacity
3.
Banks insist on changing loan tenure instead of EMI
You often see that while RBI
either cuts or raises interest rates, as the case may be, your EMI remains the
same for the entire loan tenure because it’s principal and interest ratio that
keep changing. Lenders always prefer to change the tenure than change in the
EMI. The reason is obvious as lenders have their own convenience. They do not
heed the hassles of readjusting the EMI, changing the ECS mandate and accepting
new post-dated cheques. When rates fall, reducing the tenure is beneficial for
the borrower, as the interest cost falls. However, when rates rise, a longer tenure
means you pay more interest.
Staying with above example, say
after three years the rate is revised from 10% to 9.5%. If the EMI remains the
same i.e Rs38,600, the tenure of the loan will come down by 15 months. You pay
Rs35.27 lakh, in interest for the rest of the tenure (189 months).
However, if the EMI is
re-adjusted and the tenure remains the same, you pay Rs38.52 lakh in interest during
the rest of tenure. Thus, Rs3.25 lakh is more than the interest paid during the
shortened tenure.
4.
Paying more interest than the principal loan amount
Many borrowers do not realize
that a house bought on a loan will cost them more than double the price tag.
The longer the tenure, the higher will be the interest payments and higher will
be the chance that you will pay more interest than the principal.
At 8%, you pay Rs40.30 lakh as interest
on a loan of Rs40 lakh if the loan tenure is 20 years. To maintain double price
tag, if the tenure is 15 years at rate has to be 10.6% and for 10 years at
15.9% rate at which the interest will be more than double the principal.
5.
Fixed interest rate on loans not really fixed
Generally, a fixed rate loan
should remain fixed throughout the tenure. However, some lenders do have a
reset clause saying that the rate is subject to revision. The clause ensures
decent cash flow for banks if there is any sharp increase in their cost of
funds and varies from bank to bank and is involved either after a fixed period
or a sharp spike in interest rates.
Conclusion
Before opting
for a home loan, it is always advisable to assess the impact of taking a loan
and the subsequent EMI payments on the changes of RBI monetary policies and
bank regulations as well. It is a prescribed personal finance practice to get a
new monthly budget in place which accommodates the new cash out flow in the
form of EMI payments. Therefore, it makes sense to access your affordability
and the loan's impact on your personal finance before opting for a home loan. Read:Your Home Loan and Tax Planning!
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