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Refinance Home Loan In Early Years (For Maximum Gains)

Scene 1: RBI raises the policy rates. Banks react immediately. They too increase their lending rates. Consequently, the home loan borrowers have to pay more (remember these are floating rate loans).

Scene 2: RBI brings down the policy rates. But now banks hesitate. They take ages to pass on the benefit to their existing borrowers. Moreover, this (much delayed) rate reduction is often less than the actual rate cut.

Tragic ending: The existing home loan borrowers continue to bear the burden of higher interest rate. Whereas, the new borrowers get the SAME home loan at cheaper rates.

The interest rate scenario has become highly volatile in the recent years. As such, this tragic scenario is nowadays a common feature... there are abundant cases of such interest rate mismatch. Unfortunately, RBI's many efforts to correct the situation have all failed.

Well, these modern-day bankers seem to be no different than the notorious money-lenders of the earlier times, who were known to mercilessly fleece their borrowers.

Thankfully, you have a choice:

You should not let your bank make undue profits at your expense.

One of the ways to do this is to look for a new lender. Given the competition, you will almost always find a bank which is willing to lend you money — and at cheaper rates. So all you have to do is to 'switch' the loan from the existing to the new lender.

This, by the way, is known as 'loan refinance' in the banking parlance.

Of course, you need to keep a few things in mind before you opt for loan refinancing.

First, the new refinance rate should be at least 0.50-0.75% lower than the existing rate. Otherwise, it may not work out to be a worthwhile switch.

There is no pre-payment penalty. But, the new lender may charge some processing fees. In addition, there will be administrative charges and legal expenses in transferring the loan to the new lender. This cost plus effort may nullify most of the gains of the rate reduction.

Hence, go for loan refinance, provided the difference in interest rates is significant.

Think before you make your move to refinance your loan.

Second, you will gain a lot if the loan is switched in early years. As you inch closer to the loan maturity, your savings will keep diminishing. So refinancing will not be as beneficial. Let's take a simple example.

Original Loan
Loan Amount : Rs.50 lakhs
Rate of interest : 9% p.a.
Tenure : 20 years

EMI : About Rs.45,000
Total interest payable : Rs.58 lakhs

Case 1. Loan refinanced after THREE years
Loan Outstanding : Rs.47 lakhs
New rate of interest : 8% p.a.
EMI : Assuming you continue with the same EMI of Rs.45,000

Interest paid for the first 3 years : Rs.13.11 lakhs
Interest payable after refinancing : Rs.33.55 lakhs
Total interest payable : Rs.46.66 lakhs

Savings = Rs.11.34 lakhs

Case 2. Loan refinanced after SEVEN years
Loan Outstanding : Rs.41.30 lakhs
New rate of interest : 8% p.a.
EMI : Assuming you continue with the same EMI of Rs.45,000

Interest paid for the first 7 years : Rs.29.07 lakhs
Interest payable after refinancing : Rs.22.78 lakhs
Total interest payable : Rs.51.85 lakhs

Savings = Rs.6.15 lakhs

Case 3. Loan refinanced after TWELVE years
Loan Outstanding : Rs.30.71 lakhs
New rate of interest : 8% p.a.
EMI : Assuming you continue with the same EMI of Rs.45,000

Interest paid for the first 12 years : Rs.45.49 lakhs
Interest payable after refinancing : Rs.10.39 lakhs
Total interest payable : Rs.55.88 lakhs

Savings = Rs.2.12 lakhs

As is evident from the third scenario, even though out of 20 years you still have 8 years to go for the loan to be fully repaid, the gains from loan refinancing are quite negligible and insignificant.

Remember this fact when deciding on whether to refinance your loan or not.  

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