Tuesday, April 17, 2012

Tame your Home loan: Strategies to reduce it



Easy availability of home loans has accelerated the process of owning your own house. Nisha and Rishi have bought their house three years back. It was a smooth sailing and the home loan to them was Rs.37, 286 EMI to be paid for next 20 years. With the expected salary raises, the amount could have been easily borne. But it was not long before the shockers came. Their bank called them to either increase the EMI or the tenure in order to compensate for the increasing Interest rates, ie, the cost of borrowing. In last one year they were asked to adjust their EMI and tenure for two to three times.

Only a miracle could have saved them now! So should they keep waiting for the bank to be merciful and reduce the home loan burden? This certainly won’t happen but Nisha and Rishi can make this seemingly impossible task possible by employing some thoughtful strategies.


As the saying goes ‘Know your enemy well’!  Understanding the concept of home loan is important.


Home loan constitutes of the trio: Principal (the amount borrowed from the lender), Interest (the cost of borrowing: higher the principal, higher the cost of borrowing) and the tenure (the term for which the loan is taken: again, higher the tenure, higher the cost of borrowing). 

Reducing any one of them will help us reduce the overall burden of home loan.

1. Never exhaust your borrowing limit:

Banks may be offering up to 85% of the cost of purchase of house but remember the lesser you borrow the lesser you pay back. Ideally your EMI should not go beyond 40% of your monthly expenses.

2. Prepayments:

When you are servicing a loan at 11.25% interest rate, investing in PPF , Fixed deposits, FMPs, Liquid and debt funds etc at 7-9% does not make sense. Liquidate your low yielding investments and use them to make prepayments. Prepayments will reduce the principal directly and thereby reducing the total payback.

There can be prepayment penalty in some cases, usually in first 2-3 years of taking the loan if you make the complete payment. Partial prepayments are usually allowed without any penalty.


3. Increase your EMI:


EMI is calculated by equally dividing the principal plus the interest to be paid in the specified time frame. While paying these monthly installments some portion of the principal is also paid back. EMIs are decided initially by the bank as per the amortization schedule. As the interest rate on the loan is pre decided and distributed accordingly, any further increase in the EMI will go to the principal repayment.

Eg. For a Rs.40 Lakh loan @11% increase in EMI from Rs.41,288 to Rs.46,763 will bring down the total payment from Rs.99 lakh to Rs.78 lakh. Just by putting in Rs.5000 more per month can reduce the loan by Rs. 21 Lakh.
Hence cutting down on your restaurant bills and mall trips or diverting some portion of salary raise and increasing the EMI by few thousand rupees can bring in a lot of peace.


4. Reduce the tenure:

Either you are making prepayments or increasing EMI try to reduce your tenure. If you lucky to witness falling interest rates, choose to reduce your tenure and not the EMI. Simply put, you will payback lesser amount in 180 months than you will be paying in 240 months.

5. Renegotiate the interest rates:

Banks can offer different rates to attract the new customers. These rates can be lower than the old ones. Sometimes they are just teaser rates for first one or two years. In other cases the old customers can also get benefit of such offers by paying some conversion fee. This conversion fee can be 1-2% of the outstanding balance. But if it can reduce your interest rates by 2-2.5% for rest of the EMIs, it can be worth considering.

Banks generally do not communicate such options, hence buyer should be keep in regular touch with the bank to avail any such facility.


6. Use interest saving loans:

‘Interest saving loans’ are linked to your savings account. The amount in your account is considered as the prepayment and the interest is calculated on the outstanding balance thereby reducing the overall burden. Parking your emergency amount in such accounts can be helpful since you have the flexibility to use the money.

7. Consider refinancing:

Refinancing means converting your existing high interest loan to new lower interest one. This will mean foreclosing your existing loan with the current bank and purchasing a new loan with the new bank.

While you will have to bear the penalty if any for foreclosing the loan, at the same time there will be processing fee for the new loan as well.

The option can be worth considering if interest rates offered by the new lender are not just teaser rates for a year or two but will continue during the period of loan. Read the fine prints before you go ahead. Otherwise renegotiating the rates with the current bank is preferable.

Finally: 


Any one or a combination of above strategies can be helpful in taming the ‘Home Loan’. But before considering any of the above options a thorough analysis of your present situation and future expectations is necessary. Eg. Increase your EMI only when you are sure of increase in income or there is no incremental expenditure coming up. Similarly make the prepayments once you have done sufficient emergency and risk planning.

So if miracles won’t happen, careful planning and staying informed can help!


If you wish to read about various aspects and costs involved in House purchase or wish to explore about Real Estate investing, following are the links:

http://shilpijohri.blogspot.com/2012/04/road-to-buy-your-dream-house.html

http://shilpijohri.blogspot.com/2013/11/buying-house-plan-for-additional-costs.html

http://shilpijohri.blogspot.com/2012/08/what-is-your-real-reason-for-investing.html