Home loan interest rates have risen over the 15 months. When interest rates rise, the default response by the banks is usually to increase the tenure while keeping the EMI constant. If the tenure can’t be increased because of the loan tenure breaching the contracted tenure or because you don’t want to pay for a longer tenure, the EMI must go up.
A higher EMI is a burden on your monthly budget. Well, there are ways to keep the EMI down. You can part-prepay the loan, but you must have the funds to make the prepayment. Or you can shop around for lower interest rates (home loan balance transfer) but that involves a bit of operational work.
But if you are lucky (in fact, have been rather unlucky), there may be a far simpler way.
You Just Have to Ask Your Bank
I was speaking to a friend recently. Got to know that his home loan interest rate was 9.8% p.a. Was a bit surprised given his job, income, and credit profile. And the prevailing interest rate. I asked him to reach out to the bank and ask why his loan interest rate was so high. He was not much aware about the loan benchmark and the spread, and how the interest rate for the floating rate loans is calculated. My sense was that the loan was still pegged to Marginal cost of funds based lending rate (MCLR).
Anyhow, when he reached out to the bank, the bank happily agreed to reduce the home loan interest to 8.5% p.a. Didn’t ask for any fee either. He just had to ask. That’s the power of asking questions or making a polite request.
Many home loans just work on autopilot. Not all borrowers keep track of the interest rates. EMI gets debited automatically from their account. And that’s it. While these borrowers also crib about the rising interest rates and increasing EMIs (or tenures), they don’t spend time and effort to see if they can get a better deal.
Keep an eye on interest rates in the economy. Check in your circle regularly what they are paying on their home loans. Does not matter what you feel about your current level of home loan interest rate. Even if your current interest rate does not bother you, it can be lower. We shared an instance in September 2020 when the interest rates were falling, and the borrower was fine with his loan interest rate. A simple request reduced the interest rate by more than a percent.
How Does This Happen?
Your home loan must be linked to an old benchmark. And you never bothered to check with your bank. The home loan interest rate benchmarks have evolved over the past decade and a half. Prime Lending Rate (PLR) → Base rate → Marginal Cost of funds based lending rate (MCLR) →External benchmark linked rate (EBLR).
With each iteration, the level of transparency has improved. The latest benchmark is EBLR. All the home loans sanctioned since October 2019 must be linked to an external benchmark. Most banks use the RBI Repo rate as the benchmark.
However, the regulations do not force banks to do anything about the home loan sanctioned before October 2019. Yes, if the borrower is aware, he/she can reach out to the bank, compare, and decide to switch after considering the switching costs.
What if you don’t reach out to the bank? The bank won’t say anything. If your home loan is linked to an older benchmark (MCLR or Base Rate) and you are paying a higher rate because of that, the bank would never reach out to you. After all, they only stand to gain if you pay a higher rate of interest.
Unfortunately, many borrowers don’t pay attention and never question their higher rate of interest. Since high or low is relative, it is important you have a sense of what others are paying. If you notice a wide difference, it is time to seek an explanation from your bank.
While it is important that you employ other ways to reduce the loan EMI, do not miss out on this low hanging fruit. In this case, all you have to do is to ask the bank.
What Difference Will It Make?
The interest rates of MCLR linked home loans won’t move lock in step with external benchmark linked loans. The difference will sometimes narrow and widen at other times.
However, assuming the interest rates remain the same until the end of loan tenure: 9.8% for MCLR and 8.5% for the External benchmark linked loan.
Let’s say the outstanding home loan amount is Rs 50 lacs and the remaining loan tenure is 15 years. The difference in EMIs is Rs 3,883 (Rs 53,120 and Rs 49,236). Over 15 years, this excess payment adds up to Rs 6.98 lacs.
That’s the price you pay for not asking your bank.