Factors to Consider When Doing Home Loan Transfer

Home loans form the biggest pie of loan portfolio for the most of us. Therefore, higher interest rate on a home loan can translate into a greater EMI outgo. If there is a way by which your EMI burden can be reduced, you can ease pressure on your monthly cash flows. EMI depends on both tenor and the interest rate. Higher the interest rate, higher the EMI for the same principal and loan tenor.



Therefore, you are completely justified in looking out for lower interest rate options. Sometimes, your hand may be forced too. For instance, many a time banks choose not to pass the benefit of lower interest rates (completely) to the existing borrowers. So, the new borrowers can borrow at a lower rate while the existing borrowers continue to pay higher interest rate. As an existing borrower, such behavior is likely to leave you disappointed.

What can you do? Well, you have an option. You can switch your home loan to another lender who is offering you lower interest rates. However, do not get fixated with lower interest rate alone. Try to assess the overall cost impact.  You might have to forgo some tax benefits. You might be required to pay some processing fees and other ancillary charges. Consider all these costs before you take a decision to switch the loan. Let’s start with the impact of lower interest rates.

What Is the Impact of Lower Interest Rate?

Let’s consider you have a loan outstanding of Rs 50 lacs. Outstanding loan tenor is 15 years. Interest rate is 10.5% p.a. With this loan combination, you will be paying an EMI of Rs 55,270.

The lower the refinanced loan rate, the better it is for you. If you can refinance at a rate of 10% p.a., your EMI burden shall fall to Rs 53,730 per month. That’s a saving of Rs 1,540 per month. Over the loan tenor of 15 years, this amounts to savings of Rs 2.77 lacs. If you can switch to a new lender at 9.85% per annum, your EMI burden shall fall to Rs 53,272. This will translate to savings of Rs 3.60 lacs over the loan tenor.

The greater your outstanding loan tenor, the more you will save by switching to a lower interest rate. For 20 year tenor (outstanding), Rs 50 lac loan will have an EMI of Rs 49,919 at 10.5% p.a. If you refinance at 10% p.a., you will save Rs 4 lacs over 20 years. If you refinance at 9.85%, you will save Rs 5.19 lacs over 20 years.

So, there are significant benefits to be had if you can find a lender that offers you lower rates. However, if the outstanding tenor of your loan is low, you will not gain much by transferring your loan to the new lender.

What about the Tax Benefits That Will Be Forgone?

In the previous sections, the calculations were crisp. Home loan repayments are eligible for tax benefits. If you succeed in getting a lower EMI, you will have to forgo certain tax benefits.

Home loan principal repayment up to Rs 1.5 lacs is eligible for tax deduction under Section 80C. Additionally, interest payment on a home loan (self occupied) is eligible for deduction up to Rs 2 lacs under Section 24. If you refinance your loan at a lower interest rate, your total interest outgo will decrease. With that, you can expect you will be able to avail lesser tax benefits.

The amount of tax benefits forgone will depend on

  1. Your income tax slab.
  2. The tax benefits you are already availing under Section 80C (apart from principal repayment)

I will ignore the second part in the illustration since this parameter will vary across individuals. I assume you have not made any 80C investments. So, the entire principal repayment upto Rs 1.5 lacs will get you tax deduction under Section 80C. The principal repaid in both the cases remains the same. Hence, there shouldn’t be any difference in the absolute tax benefits taken for principal repayment. However, there can be minor difference due to capping on the tax benefit for principal repayment.

Tax benefit for interest payment of home loan under Section 24 is an exclusive tax benefit. No other expense or investment is eligible for benefit under this section. If you opt for a lower interest rate, your interest liability goes down. So, you can expect the overall tax benefits to go down.

However, the capping on tax benefits can throw surprising results sometimes. Let’s see the impact.

O/S PrincipalO/S Tenor (Years)Interest RateEMIInterest Cost SavingsTax Benefits Forgone (30%)Net Savings (30% slab)Tax Benefits Forgone (10%)Net Savings (10% slab)
50 lacs2010.5%49,919NANANANANA
50 lacs2010.0%48,251400,299-802401,101-267400,566
50 lacs209.85%47,755519,304-766520,070-255519,559
50 lacs1510.5%55,270NANANANANA
50 lacs1510.0%53,730277,1447,340269,8042,447274,697
50 lacs159.85%53,272359,56610,400349,1663,467356,099
20 lacs2010.5%19,968NANANANANA
20 lacs2010.0%19,300160,12039,018121,10213,006147,114
20 lacs209.85%19,102207,72151,973155,74817,134190,587
20 lacs1510.5%22,108NANANANANA
20 lacs1510.0%21,492110,85826,48184,3778,827102,031
20 lacs159.85%21,309143,82635,083108,74311,694132,132

You can see something interesting. You would have expected that you will have to forgo at least some tax benefits if you switch to a lower interest rate. But that’s not always the case. For Rs 50 lacs loan, you are not really losing out on anything. That’s because there is a cap of Rs 2 lacs on tax benefits on interest payment on home loans.

However, if you consider loan of Rs 20 lacs, you can see a significant impact. A good portion of your interest cost saving is nullified through tax benefits forgone. For instance, if you switch your Rs 20 lacs loan (20 years, 10.5%) to 9.85%, you will save interest cost to the tune of Rs 2.07 lacs. However, you will lose tax benefits of Rs 51,973 (30% tax slab). Hence, the net savings will come down to Rs 1.55 lacs. Do notice the impact of income tax slab.

Note: I have not discounted the cash flows to see the true impact. I have only considered absolute cost savings.

Consider Other Switching Costs Too

You might have to pay some fee for foreclosure of loan with the existing bank. The new bank might charge some processing fee.  There can be legal charges or mortgage documentation charges. There can be a host of other charges. Be sure of all the hidden charges.  You might have purchased home loan insurance from the existing lender. Depending upon the terms and conditions of the insurance contract, you may or may not be returned any premium. You may have to purchase another such plan with the new lender. All these things add to the cost of home loan transfer.

Let’s suppose all these ancillary costs go up to 2% of the outstanding amount. You were saving interest cost to the extent of Rs 84,377 by refinancing your loan (20 lacs, 15 years, 10.5%) at 10%. You will have to spend Rs 40,000 towards these charges.  So, the net savings come to Rs 44,377. You need to see if it is worth the effort.

Conclusion

Switching your home loan to a new lender that is offering you lower interest rate can save you a lot of money. However, you should assess the overall cost (and not just interest rate difference) before you make the final decision. Several processing, documentation and other hidden charges can easily nullify the cost savings from a lower interest rate. You will have to put in some effort. Do some math to arrive at the net cost savings and make the decision.