Given the property prices, most of the home buyers take a home loan to fund the purchase. While finalizing a loan product, one of the critical decision factors is the loan interest rate. Clearly, you would prefer the lowest rate of interest. Competition in the home loan segment has ensured that the interest rate for an occupation or credit profile are in a similar range. Still, there can be a difference. Moreover, since home loan amount is big and tenure long, the impact of saving even a few basis points can be quite large. Difference of 15 basis point in interest rate can mean paying Rs 1.15 lacs more for a Rs 50 lac loan over 20 years.
Even home loan products from the same banks can come at different rates. The difference in interest rate in products from the same bank can be due to a novelty (variation from the regular product) in the product. There can possibly be two types of novelty that a home loan product can offer:
- Products that offer higher eligibility
- Products that offer anything else (most likely a pretense of lower interest pay-out)
The Loan Products That Offer Higher Loan Eligibility
We have discussed step-up home loans and step-down loans in our earlier posts. With such loans, banks take a higher risk. By tweaking around their eligibility criteria, they let go you get away with a higher loan eligibility. Sometimes, the loan eligibility can be up to 20% higher. Hence, I can understand if the loan interest rate is a bit higher. I won’t take a call about whether you should go for such a loan product. Assuming there was only 1 bank in the world, and it offered only two products.
Loan Product A: 9% p.a. with your loan eligibility of Rs 40 lacs
Loan Product B: 9.2% p.a. with your loan eligibility of Rs 48 lacs
If you needed a loan of only up to Rs 40 lacs, it makes little sense to look beyond product A. However, if you need a loan of about Rs 45 lacs, you have only 3 options.
- Postpone the purchase till such time your eligibility or loan requirement goes down
- Take a loan of Rs 40 lacs under product A and arrange the remaining amount through other means (borrow from friends/family, sell an investment etc)
- Go for the Product B
What you do is clearly your choice. By the way, the interest rate for product B may not always be higher. The point is that even if the interest rate is higher, your hand is forced. Moreover, to an extent, the bank is justified too. It is taking a higher risk by lending more to you.
With loan products that offer higher eligibility, you may consider paying a slightly higher rate of interest.
Do note, this concept of FOIR (Fixed obligation to income ratio) is there for a reason. If bulk of your income goes towards home loan EMI, how will you run your household? These higher loan eligibility products tweak the repayment structures to ensure that you comply with the banks FOIR threshold. However, you need to appreciate the risk involved. Your salary may not grow as expected or the joint borrower may pass away.
What about the Other Home Loan Products?
Just don’t fall for it. There is no need to pay a higher interest rate for any home loan product that does not offer you higher eligibility.
We discussed a loan product from Axis Bank (Axis Quick Pay), where the principal payments were expedited during the loan tenure. The product illustration showed how you would save a lot of money despite paying a higher rate of interest. I showed that you can easily replicate the same repayment structure under a regular home loan product through timely repayments. Why should you pay a higher rate of interest? Remember, home loans do not have prepayment penalty.
An exception is a home saver loan (for example, SBI MaxGain). A home saver loan can provide you benefits of prepayment without actual prepayment. Besides, you maintain liquidity with the prepayment money (in case of actual prepayment, you would have no access to that money). Additionally, since the interest saved is interest earned in case of such loans and loan interest rate is higher than your bank fixed deposits, these home saver loan products have merit. By the way, it is not that you will be charged a higher rate of interest with such loans. After all, there is no additional risk that bank takes with such loans. Therefore, there is no point banks should charge you a higher rate of interest in such loans. Even if they do, you need to weight the benefits of higher liquidity against higher cost.
Here is what you need to do.
- Lower the interest rate, the better it is.
- Do not pay a higher interest rate except for higher eligibility. Even there, exercise discretion. The interest rate shouldn’t be too high.
- Do not ignore ancillary charges such as processing. However, the impact of such charges on the overall cost of loan goes down with loan tenure. The impact is high for short term loans.
The focus of this post is on the loan products where the interest rate is higher than the regular home loan product. It is unlikely that the interest rate will be lower than a regular home loan product. If that’s the case, dig deeper. There must be some caveat.