When To Opt For Balance Transfer Of Your Home Loan – Detailed Analysis

Should Ram switch his home loan?

Ram, a 32-year-old engineer, had taken a home loan of Rs 20 lakh for 20 years at a fixed interest rate of 13 per cent. He still has ten years remaining on his loan. Now, he is planning to shift the loan to another bank which is offering a fixed interest rate of 11 per cent. But Ram will have to pay a prepayment fee of 2 per cent on his existing loan. He doesn't mind to pay the penalty as long as he saves a considerable amount in EMI. So should he go ahead with his decision?

How can Ram save money?

The following equation will help find out whether Ram will be able to save money by switching his home loan from one bank to another.

It shows that if the prepayment fee is less than the amount saved from the new reduced EMI, then only there will be net profit for Ram. Find out your new EMI.

Getting your facts right and clear

Let us see what Ram has to consider before finalising the loan switch.

Case Facts:
• Prepayment penalty of 2 per cent for shifting the loan
• In case of refinancing, banks usually add the prepayment fee to the new loan, and there is no one-time payment to be made.
• EMI of the new loan thus includes the prepayment fee. What will be your prepayment fee?
• Ram's loan amount was Rs 20 lakh, but over the last 10 years it was reduced as some principal has been repaid.
• New loan is available for Ram at a rate of 11 per cent for a period of 10 years.

What will Ram's actual savings be?

We will carry out some calculations to know how much Ram saves in actual.

Thus, Ram saves Rs 1.65 lakh over 10 years by shifting his loan.

Considering other interest rates

We see that Ram stands to gain from refinancing his home loan at an interest rate of 11 per cent. But what if the new loan was offered at 10.5 per cent or for that matter any other interest rate? Above what interest rate of the new loan should Ram not shift his loan?

If we calculate Ram's savings at some possible interest rates of the new loan, we get the following result:

This means, Ram benefits by shifting his loan to another bank at any rate below 12.4 per cent. However, it makes sense for Ram to wait for at least a 1-2 per cent difference in the rates before switching the loan. Find out whether refinancing is beneficial for you

Summing it up

• A small amount saved on Ram's EMI per month adds up to a significant sum over the duration of his loan (i.e., 10 years).
• An interest rate differential of as little as 0.5 per cent might be a good incentive for Ram to shift a home loan to another bank.
• Prepayment penalty reduces the savings achieved by shifting the loan. So, it will take almost 3-4 years to neutralise the effect of prepayment penalty and to realise the benefits of shifting the home loan for Ram.