Personal Finance: Cost-Savvy Switchovers

PERSONAL FINANCE: HOUSING LOANS
Cost-Savvy Switchovers

Saddled with a high-cost housing loan? No problem. There are enough financiers today who'll trade in yours for a cheaper loan.

By Dilip Maitra

Last year, Chitra and Suresh finally sewed up the home loan deal they had been eyeing for what seemed an eternity. The couple thought they had a nice bargain in the bag. As an exception, the housing finance company had given them a 0.5 per cent mark-down on the prevailing interest rate.

But today, Chitra and Suresh feel cheated. The interest rates are down by 2 percentage points, but the 'double-income-no-kids' couple is stuck with a higher rate. Clearly, being an early bird did not help them. Does it mean that the couple has no choice but to live with a more expensive debt? Fortunately for them-no.

Thanks to the new competitive housing finance market, borrowers have the option of trading in their old expensive loans for newer, cheaper ones. It's called loan switching, and it is fast becoming popular. Agrees Kranti Sinha, 58, Director and Chief Executive, LIC Housing: ''Loan switching is a recent phenomenon, but the demand is so strong that no housing finance company can ignore it.''

How It Works

If your housing loan is three years old or older, you probably are paying an interest rate of around 16 per cent per annum.

If the loan is for a period of 15 years, the equated monthly instalment (EMI) should work out to Rs 1,600 per lakh or Rs 16,000 per month for a loan of Rs 10 lakh.

In the three years, the principal amount outstanding in your loan account should have come down to Rs 8.50 lakh. If you are wondering why after having repaid Rs 5.76 lakh in 36 months your principal is still so high, it is because in the initial years a larger chunk of your EMI goes towards payment of interest on the loan.

Before signing up, find out the rate of interest being offered by banks like the State Bank of India (SBI), Punjab National Bank, and Corporation Bank, who are very aggressive in housing loans, and also with Housing Development and Finance Corporation (HDFC), ICICI, and LIC Housing.

These days, housing finance companies (HFCs) are charging interest rates between 12.5 percent (HDFC's and PNB's floating rate) and 13.25 per cent (SBI). So, if you strike a deal at 13 per cent for a 12-year (15 years minus the three years already covered) loan period, your EMI on a Rs 8.5 lakh loan (the amount taken over) will work out to Rs 12,000. That's Rs 4,000 less per month than what you are paying at the current rate. In a year, the switchover will save you Rs 48,000, and over the 12 years, a staggering Rs 5.76 lakh. The savings will be more if you include the interest-earning potential of the money you saved in EMI.

There are some implicit switching costs you need to take into account before making the move. Many institutions (like HDFC and LIC) and foreign banks like (Citibank) charge a pre-payment, or foreclosure, penalty varying between 1.5 per cent and 2 per cent of the loan pre-paid. Assuming a penalty of 2 per cent, the cost of foreclosing Rs 8.5 lakh will be Rs 17,000. Add to that processing charges of 1.8 per cent (at HDFC, Citi, and ICICI) or Rs 15,300.

Still, calculations show, that you are left with a first-year saving of Rs 15,700. A PSU bank loan may give you further saving as the processing charges are far lower. SBI, for example, charges only 0.5 per cent, while PNB charges only Rs 150 for every one lakh. Says S.N. Nagendra, 42, Deputy General Manager, HDFC: ''Go for loan switching only after calculating all the hidden costs. The gain should be big enough to justify all the trouble.''

Boost Disposable Income

Loan switching also helps when your existing financier reduces the rate of interest to match competitive market rates. This is how. Assume that the rate of interest is dropped to the current level of 13 per cent. You would expect the EMIs to come down accordingly, right? Wrong, because most of the HFCs do not lower the EMI amount. Instead, they reduce the number of EMIs to match the lower interest cost. In other words, you keep aying the same amount, but for fewer months.

Is this fair? As far as the HFC is concerned it is, because it saves them the trouble of having to re-calculate the EMI every time there is a change in the interest rate. But it doesn't help you.

Consider the earlier example where you borrowed Rs 10 lakh and paid Rs 16,000 as the EMI. If your HFC decides to pass on the benefit of a lower rate to you through a reduction in the number of EMIs, the latter may come down by about 36 months or three years. You would probably feel happy at the thought of wrapping up your debt in a shorter time. Your joy is not totally warranted. If you factor in the likely increase in your disposable income, the rate of inflation, and the present value of money, you are better off with a lower EMI than a shorter EMI period.

When a person takes a loan early in his career, the monthly EMI constitutes a large part of his disposable income. Thus, he has to adopt several austerity measures to make ends meet. Generally, earnings of most salaried people rise faster than the rate of inflation, and as the years go by, loan repayment gobbles up less of the disposable income. In short, a reduction in EMI today is more important than saving a few lakh 10 years down the road.

It makes economic sense, too. Assuming an annual inflation rate of 6 per cent, in 10 years the compounded rate of discounting will reduce the value of rupee by half. Loan switching, thus, will not only reduce your EMI payment to Rs 12,000, but the rupee value of the EMI will be reduced to Rs 6,000 after a decade. It is for this reason that some HFCs do not reduce the rate of EMI. Says HDFC's Nagendra: ''Our general rule is that we do not reduce the EMI amount. But in some cases, we are prepared to consider that.''

In other words, it is competition that is forcing the large players to change their 'take-it-or-leave-it' attitude. But now, the rules of the housing finance game are being re-written. Do not hesitate to ask for-nay, demand-a reduction in the interest rate and the EMI. If your HFC does not budge, walk across to the competitor's office.

Here's some parting advice: If you think tracking interest rates is not your cup of tea, go for a fixed loan where the rate of interest does not change. But make sure it is from somebody who does not charge pre-payment penalty.

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