When Should You Consider Refinancing Your Loan?

Refinancing a loan simply means availing a loan from a new lender to pay off an existing one. You approach a new lender for loan refinancing/balance transfer. The new lender sanctions the loan and settles your loan outstanding with the existing lender. Subsequently, your obligation with the existing lender terminates and a new repayment obligation towards the new lender starts.

There are various reasons why you may look for loan refinancing. Let’s look at some of the scenarios when you should consider loan refinancing.

#1 Get a Lower Interest Rate

It is quite possible that you are stuck with a very high rate of interest on your loan. New customers are getting it at a much lower rate. When you enquired with the bank, the bank either declined your request or asked you to pay a hefty fee to switch to a lower rate. If you do not want to pay switch fee, you can consider getting your loan refinanced from another lender.

For those who have taken loans on or after April 1, 2017, their loans will be linked to MCLR (marginal cost based lending rate). With MCLR, banks do not enjoy much leeway and are forced to pass on the lower (or higher) rate to you on interest reset date. However, even in this case, it is quite possible that MCLR for your bank is higher than the other bank. Or the spread at which you got the loan is quite high. For instance, if spread for your loan is 75 bps while the new loans are being sanctioned at a spread of 25 bps, you may get a bit uncomfortable.

#2 Extend the Loan Tenure

Sometimes, affordability of an EMI could be an issue. Your EMI is a function of the principal outstanding, interest rate and home loan tenure.  You can’t do much about principal outstanding. Interest rate is decided by the bank. You can’t do much about it either. Hence, if you are finding your EMI too difficult to handle, you can request your bank to extend the loan tenure. To assess the impact on EMI, EMI for Rs 20 lac loan at 9.5% p.a. for 15 years will be Rs 20,884. If you increase the tenure to 20 years, the EMI goes down to Rs 18,642.  EMI goes down by almost Rs 2,200. If your lender does not agree to increase the loan tenure, you can consider a loan refinance from another lender.

#3 Change in Financial Status

When you took the loan, you were self-employed. You couldn’t even get a loan from bank. You had to approach an NBFC for your home loan. The loan interest rate was quite high, but there was no other option. You had to settle with a high rate of interest. After 5 years, you are now in a stable job. You may now consider applying for refinancing from the bank. The bank may now offer you loan at a much lower rate.

#4 Move from Fixed Rate Loan to Floating Rate Loan

You are stuck with a fixed rate loan at a high rate while the interest rates have moved down sharply. If your bank does not let you switch to a floating rate loan or charges a heavy penalty for the switch, loan refinancing is the only option left. You may still have to pay a prepayment penalty for pre-closure of your loan with your existing lender.

#5 Consolidate Loans

This is better applicable in case of credit card debt or personal loans. If you are finding it difficult to meet repayment obligations, you can talk to another lender for balance transfer. Not only can it help you in consolidating debt but you will most likely get favourable repayment terms too. By consolidating your debt, you get a better view of financial position. In my opinion, it is easier to manage one big problem than managing multiple small problems.

In case of credit card debt, you can see the negative power of compounding in full flow. A balance transfer to another bank can reduce cash outflow pressure and help you get back on track.

#6 Top-up Loan

You purchased the house 10 years back. In these 10 years, the value of house has appreciated to Rs 80 lacs while the outstanding loan amount is down to Rs 10 lacs. You need money for home renovation or to start a small business. A top-up home loan could be an option. If your existing lender does not agree to offer top-up loan or if you don’t find the terms of offer too attractive, it would be a good idea to talk to another lender and refinance home loan if the lender offers attractive terms.

#7 Dissatisfaction with Service

Dissatisfaction can be due to multiple reasons. The bank is slow in passing rate cuts while quite proactive in passing interest rate hikes. If the bank does not respond to your queries or service requests or if you happen to somehow pick up fight with the branch official whenever you visit the branch, you can consider shifting lender. If you pick up regular fights with the branch officials of new lender too, the problem is with you (and not the bank).

What Should You Do?

Even though I have mentioned many reasons why you would look for a loan refinancing, loan refinancing has its own costs. You must figure out all the costs of moving to a different lender. There may be prepayment penalty by existing lender (for fixed rate loans). Do consider processing fee, valuation charges, MoD charges etc. Do not just focus on the difference in interest rates. Since you are changing your lender, the entire process wouldn’t be as hassle-free as it would have been if you had decided to switch to a lower rate with the same lender by paying a fee. Moreover, it is quite possible that your existing lender may make you a counter-offer (of a lower rate) when you intimate your decision to switch to another lender.

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