Teaser rate home loans, which come with a fixed rate of interest for the first few years, have been the talk of the town lately.
Unfortunately, banks and housing finance companies are offering these only to new customers and not existing ones.
So, does it make sense for an individual to move from a normal floating rate home loan to a teaser home loan? DNA does the math.
The case study
A couple has borrowed Rs 28.99 lakh at the rate of 10.5% for a period of 15 years, starting with an equated monthly installment (EMI) of Rs 32,050.
Repayment began in January 2008, and after the roller coaster ride of interest rates since, the couple now pays an interest rate of 10.25% and has 155 EMIs due.
Of the Rs 28.99 lakh loan amount, around Rs 1,50,450 has been repaid. This leaves Rs 27.49 lakh as outstanding.
Switch sense
A switch makes sense only if the cost of switching is lesser than the savings made from the lower EMI of the first few years. The cost of switching includes the prepayment charges on the old loan and the processing fee on the new loan.
The couple will have to pay a prepayment charge to the old bank, and a processing fee to the new lender. Typically, most banks and housing finance companies will charge 2-3% of the outstanding amount if a borrower decides to refinance. Also, the new bank will charge its own processing fee, which ranges from 0.5-1% of the loan amount.
The options
There are several teaser rate loans in the market. So let us consider two options:
Option A: This scheme charges a fixed rate of 8% in the first year. The EMI at 8% for a home loan of Rs 27.49 lakh to be repaid over 155 months works out to Rs 28,505. Compared to the original EMI, this amounts to a saving of Rs 3,545 a month or Rs 42,540 a year.
Let us also assume that for the second and the third year, this loan charges a rate of 8.5%. At this rate, the EMI works out to Rs 27,840, implying a saving of Rs 4,210 from the original EMI, or Rs 1,01,040 over two years. So, at the end of three years, the total saving would amount to Rs 1,43,700 (Rs 42,540 + Rs 1,01,040).
Option B: This loan charges 8.25% for the first two years and a floating rate after that. At 8.25%, the EMI on Rs 27.49 lakh to be repaid over 155 months works out to Rs 28,888. This amounts to a saving of Rs 3,162 per month, or Rs 75,888 over the two-year period.
Go for it?
Option A: The current outflow is the prepayment charge plus the processing fee. At 2%, the prepayment charge comes to Rs 55,000 and at 3%, it comes to Rs 82,500. Now, add the processing fee for the new lender. At 0.5%, it works out to Rs 13,745. Some banks like State Bank of India charge a maximum of Rs 7,000. Assuming the prepayment charge is 3% and the processing fee is Rs 7,000, the total cost of making the switch works out to Rs 89,500. The total savings over the three-year period works out to Rs 1,43,580. So the real savings are around Rs 54,000, or roughly 1.7 months’ EMI (54,200 divided by 32,500). At a prepayment charge of 2% and Rs 7,000 processing fees, the real savings work out to Rs 81,580 or around 2.5 months EMI.
Option B: The prepayment charge at 2% is Rs 55,000 and at 3% is Rs 82,500. Add to this 0.5% processing fees of Rs 13,745, and the total charge works out to Rs 68,745 in case of 2% prepayment charge, and Rs 96,245 in case of 3% prepayment charge.
The savings in this case work out to Rs 75,888. Thus, it doesn’t make sense to switch loans in this case, given that even in the best possible scenario the saving made is only around Rs 7,143 (Rs 75,888 - Rs 68,745).
A caveat: this calculation doesn’t take into account what will happen after the fixed interest rate period of the new loan is over. Where the interest rates will be at that point of time is difficult to predict, but as has seen, when it comes to floating rate interest rates of existing customers, the rates of various banks and housing finance companies are similar.
Bottomline
As the numbers clearly point out, in option A, there are some savings to be made, but they are worth around 2.5 months EMI. Is that enough to go through the entire tedious exercise of switching a home loan is an individual decision.
In option B, there are hardly any savings to be made. But here, it might not be a bad idea to approach your bank or housing finance company and tell them you are thinking of switching… They might just offer you a lower interest rate.
And finally, given the math, in case you decide to carry on with your existing home loan, remember, it’s not such a bad decision.
Comments