Prepayment or Home Loan Balance Transfer: Which One Should You Choose?
In the past few months, the Reserve Bank of India has raised the repo rate or the repurchase rate by a total of 50 basis points, taking it to 6.50 in total. This has resulted in a subsequent increase in the marginal cost of funds based lending rate (MCLR), which in turn has led to a ride in the Home Loan interest rates. In line with this, the interest rate payable by both, new as well as existing customers has a hike. Evidently, it will lead to an overall increase in burden on the borrowers of this substantial credit.
Commonly, there exist two ways of reducing the overall interest outgo – Prepayment of the Home Loan or Home Loan Balance Transfer. While the former is feasible for those people who can manage to pay substantial sums of money to cover the outstanding loan balance, the latter is for those who can find a lender who offers a lower rate than their existing bank.
In order to understand, which of these two options will work best for you, you ought to know the nuances of both of them.
Home Loan Prepayment
As the term indicates, prepayment refers to the early payment of the outstanding loan amount, in part or full. In case you need to make the advance payment in part, the amount paid must be equal to or more than two months’ of equated monthly instalments (EMIs).
If you have a floating rate Home Loan, you will not be liable to pay any prepayment penalty. If however, you are servicing a fixed rate Home Loan, you may be asked to pay anywhere between 0.5 to 2.5%, and in some cases even up to 5%. This is necessarily a measure to recoup the losses that the bank suffers due to the lost interest. Moreover, it is a tool to deter you from making prepaying your loan. To avert this, it is best that you negotiate the terms of the loan before signing the agreement and make sure that the penalty is as little as possible. If that ship has sailed, it is advised that you compare the benefits of making prepayment against the cost of the same. If you find the deal to be beneficial, only then should you go ahead. If not, it is better that you stick to your regular schedule of paying the EMIs.
Given that the better part of interest charged on a Home Loan is levied within the first 7 to 9 years, it is recommended that you start making prepayments at the earliest possible so as to gain the maximum benefit. Later prepayments will not help you save much on interest, thus making the whole exercise rather worthless. Of course, if you merely want to do away with the financial commitment of making EMI payments, then even late prepayments make sense.
Not only will prepayment offer you the much-needed peace of mind, but will also help you regain the ownership of the house at the earliest. Besides, it will also help you allocate your income towards other financial obligations.
While prepayment might seem like the right, and often the most important thing to do, you must always make sure that you have sufficient funds set aside for any unforeseen emergencies, before putting all your funds towards the prepayment. Again, if you find an investment option that would help you earn more than you will be saving by prepaying, then you should use your excess funds towards the investment alternative.
Home Loan Balance Transfer
As the name suggests, Home Loan Balance Transfer(HLBT) refers to transferring your balance Home Loan from your existing bank to another bank in lieu of better interest rates. This can prove to be an excellent alternative for you if you do not have the required quantum of saving that is needed to prepay the loan, but you still wish to reduce the overall interest outgo towards the mortgage. Then again, HLBT will prove to be beneficial for you, if you are currently servicing a fixed interest Home Loan, but foresee a drop in interest rates in the near future. In this case, shifting to a lender who offers a floating rate loan can help you save a significant amount of money that would have otherwise gone towards the interest.
As is the case with prepayment, HLBT also proves to be more beneficial if undertaken in the first few years of the loan. That being said, you must always compare the cost of HLBT, with the amount of savings that you expect. Here the cost of balance transfer refers to the one-time payments that you will be required to make to avail this facility. These charges include – prepayment penalty charged by your existing bank, processing fee charged by your new lender, valuation fee, legal fee, and documentation fee amongst others. Only if the calculations suggest that you will end up on the benefitting end, even after making these payments should you go ahead with your decision! If not, you should instead continue with your existing banks.
Then again, before going ahead with this alternative, it is advisable that you talk candidly about the situation with your existing bank. In a vast majority of cases, it has been seen that the current bank reduces the rate to match the offer of the new bank. Not only will this save you from the hassle of transferring the loan, but will also help you save the money that would have otherwise gone towards the one-time charges discussed above.
We hope that you now have a clear idea regarding two of the most effective measures that can help you save interest on your loans. Now, depending upon your savings, as well as other factors discussed above, you should arrive at a decision that will prove to be the most beneficial for you.
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