Almost a month after the Reserve Bank of India (RBI) reduced the repo rate by 25 basis points (bps) in February, banks have started revising the marginal cost of funds-based lending rate (MCLR) downwards, though marginally. MCLR is the lowest possible interest rate that a bank can charge for a home loan, and one bps is one-hundredth of a percentage point. Since 1 March, banks, including Punjab National Bank, Bank of Baroda and Kotak Mahindra Bank, have reduced their MCLR for various tenures by 5-10 bps. More rate cuts may follow in the next few months, with RBI expected to cut rates in its forthcoming monetary policy review in April.
As more banks cut MCLR rates, you may get tempted to switch to a home loan that costs less. However, a reduction in rate may not always mean you will save in terms of overall costs. So do a cost-benefit analysis to ensure the switch benefits you in the long run.
Though RBI cut the repo rate by 25 bps, banks have reduced MCLR only by 5-10 bps, another example of poor rate transmission.
Financial advisers and experts do not see merit in switching a home loan for such a narrow difference. Melvin Joseph, an investment adviser registered with the Securities and Exchange Board of India and founder, Finvin Financial Planners, said that the interest rate difference should be at least 50 bps compared to your existing home loan interest rate in order to make any meaningful impact on your overall savings.
A rate cut can be a good nudge for home loan borrowers of non-banking financial companies (NBFCs) to switch their loans to banks. “What happens in many cases is that people want to take a home loan from a public sector bank but are unable to do so because of time constraints or lack of income-related documents. Such consumers go to an NBFC for the loan and are charged a higher price," said Virendra Sethi, head, mortgages and other retail assets, Bank of Baroda. If they maintain a good repayment track record, their credit score would improve, and they will be able to approach a bank to refinance their outstanding loan at a lower rate.
Bank of Baroda is currently offering home loan balance transfer to borrowers having a credit score of over 725 and a repayment record of at least 12 months, without asking for their income proof documents. However, this is not applicable on under-construction properties and properties that do not have a clear title. Borrowers with a score of 760 and above get the loan at 1-year MCLR and those having a score of 725-759 get the loan at a premium of 25 bps over 1-year MCLR.
Switching a loan entails costs, such as processing fee, documentation charges and stamp duty charges that varies across states. It is important that you clearly understand the charges and make sure that the net gains that will accrue to you after the switch are higher than the switching charges.
“You can make a comparison only if you know all the charges involved. Look for promotional offers from banks that waive off these charges. Even banks like State Bank of India, taking a loan from which is considered tedious by many people, is aggressive in this segment now. Banks are likely to waive off at least some charges if you are a customer with a good credit profile," Joseph said.
Once you know the interest rates and the charges, the next step is to calculate how much you will be able to save by switching your loan over the remaining tenure (see graph). “Though any difference in total interest repayment over the same remaining tenure is a gain, a borrower should look at it as a percentage of the loan amount. The savings being generated out of the switch should be meaningful and should also factor in the possibility of an increase in interest rates in the future. Suppose the interest rate goes up by 1% in the future, it should be compensated with the savings," said Prakash Praharaj, founder, MaxSecure Financial Planners. Even if you plan to go for a longer tenure for the transferred loan amount, the comparison needs to be done over the original tenure.
But if you plan to prepay your home loan in the near future, don’t consider refinancing. Instead, focus on aggressive repayment, Joseph said.
In December 2018, RBI had announced that all new floating rate loans from banks will be benchmarked to an external benchmark from April 2019. Once this gets implemented, transmission of rate changes in home loans is expected to be transparent and faster.
So instead of going for a home loan balance transfer now, it would be better to wait for the new regime to kick in. “Our sense is that it will come through soon. Even if it does not happen from 1 April, it will happen soon," said Gaurav Gupta, founder and CEO, myloancare.in.
However, external benchmarking will only cover loans taken from banks. “Even if delayed, a change in rate gets transmitted over time in banks. But yes, in case of housing finance companies (HFCs), the rate cuts rarely get transmitted, while the rate increases get transmitted quickly. People who have borrowed from HFCs can switch to banks in the long term. They shouldn’t switch to another lender with a lower rate, but to a bank with a lower rate, to ensure future transmission of rate cuts," Gupta said.
However, if your applicable interest rate is higher than the options available in the market and you have a good credit profile, it is possible to negotiate and get a lower rate from your existing lender. If that does not work, wait for the rates to go down further.