To switch home loan or not: How to take the decision

Home loan space has become increasingly competitive lately. What with SBI and ICICI Bank decreasing their home loan rates; and HDFC and ICICI Bank increasing the prepayment penalty from 2 to 3 per cent and 2.25 per cent respectively.

What does this mean to you?

Let's understand the impact of prepayment penalty through an illustration. Vinay has an existing fixed rate loan at 11.75 per cent rate of interest. The outstanding loan amount is Rs 10 lakh and the remaining period is 14 years.

Vinay would be paying an EMI of Rs 12,156 to complete his loan within the time period. He also needs to pay a 2 per cent prepayment penalty for repaying his loan early.

Now, if another bank offers home loan at 8.75 per cent interest rate, should Vinay go for the new offer. A quick working shows:

2 per cent penalty = Rs 20,000

EMI for the new loan = Rs 10,343

Monthly savings = Rs 1,813

The benefit, here, will be in terms of a lower EMI for the same period.

Analysis

Vinay benefits from making the switch despite paying the prepayment penalty. The amount he saves is far higher than the switching cost that will have to be paid.

What happens when the bank raises the prepayment penalty to, say 3 per cent? A similar working would have to be done for the loan to see whether the switch is beneficial. However, this higher rate of penalty is likely to be applicable for new loan takers (as in most cases). In such a situation, existing borrowers will have to base their workings on the rate that is actually prescribed for them.

Tackling prepayment penalty

Go for loans with no prepayment penalty. Not all types of loans have such a penalty. Usually, fixed rate loans have this penalty while floating rate loans are spared from such a condition.

Lower rate

There might be times where avoiding the penalty is not possible. The best way to tackle such situation is to first check out the actual prepayment penalty rate. The lower the rate the better it is for you.

However, switching loan depends on the real benefit that you get in the form of the new rate applicable. Remember, you need to consider the overall benefit over the life of the loan, and not just the immediate impact.

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