If home loan borrowers who want to shift to a new lender do not get their maths right, they might end up paying more
Given the fact that the interest rates have been fluctuating like a yo-yo in the last four to five years compared to its fluctuation intensity earlier (prior to 2008-09), the existing home borrowers have felt the heat of increase in their EMIs or increase in their repayment tenures.
Every 0.50 per cent increase in the interest rates by the RBI leads to an increase in the EMI outflow, draining your earnings. In their quest to continue with an unchanged EMI, home loan borrowers look for opportunities with other banks or HFIs that offer lower rates compared to the existing ones.
Assuming you have taken a home loan from a bank/HFI at 11 per cent and you are thinking of shifting the same to another lender who has offered 10 per cent, technically you could be doing a right thing, but there are a few aspects that you have to keep in mind before you actually ink your signatures on the new loan documents.
1. A reduction in the EMI if shifting to a new lender might sound good on the savings front but watch out for the interest rates
2. The cost of sourcing funds differs from bank to bank and that is why the deposit and lending rates are not the same everywhere.
3. When you are shifting your loan your paperwork is laborious and you may have to pay a processing fee to the new lender
A reduction in EMI
A reduction in the EMI, if shifting to a new lender, might sound good on the saving front but when it comes to interest rates we have to bear in mind that every lending institution would have a cost at which it would have sourced funds. For example, if you were to be a lender and you have sourced the funds at nine per cent, then you would perhaps want to lend it at 10 per cent, thereby keeping your profit margin or spread at one per cent.
During your course of sourcing (borrowing) funds to lend, what if your cost of borrowing goes up to 9.50 per cent? Would you still lend at 10 per cent, thereby reducing your margin to 0.50 per cent? No. If you are a businessman you would increase your lending rate to 10.50 per cent, thereby retaining your margin or profit spread at one per cent. Every time your cost of funds increases you would increase the lending rates, thereby maintaining your margin.
All banks/HFIs continuously get funds from various sources including encouraging deposits at various rates to meet the credit demand. As and when the rate of deposits goes up, the lending rates would be adjusted to keep the spread intact.
The rates that are offered by a lender would not be static or consistent; and that is the reason for banks/HFIs offering floating rates so that such adjustments can be made without any big impact on their spread.
What is to be noted is that the cost of sourcing funds could vary. One bank might be able to source it cheap while another might have a higher cost and that is the reason why the deposit rates and lending rates are not the same at all banks/HFIs.
If you shift your loan to a new bank/HFI you are also exposing yourself to the risk of being aligned to higher interest rates in the future if the cost of funds go up for the institution. This happens because you would have opted for a floating rate.
Currently banks follow what is called as Base Rate which is the minimum interest rate of a bank below which it cannot lend, and all banks are allowed to choose their own base rates which would be in line with their cost of funds.
Please bear in mind that if the interest rate variations are over one per cent between your current lender and the new lender it might make sense, but at lesser variation it may not make a long term sense if you are thinking you would save a few lakhs.
Moreover, when you are shifting your loan your paperwork is laborious and also you may have to pay a processing fee to the new lender.
Seek a good advisor or a seasoned banker who should guide you through your dilemma.