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Can home-loan refinancing provide financial respite in these times?

Refinancing is a good option especially when market rates are cheaper by atleast one percent. However, be aware of switching costs and go for it only when the existing lender doesn’t budge.

With the onslaught of the coronavirus pandemic, salaries have been cut drastically for some while others have been asked to fend for themselves. In these tough times, will home-loan refinancing provide the much-needed financial succour for those ridden with debt?

First of all, let’s understand the term home-loan refinancing, which is also popularly known as ‘balance transfer’. It essentially refers to availing a new loan from another lender to pay-off an existing one.

It makes sense to switch your home loan on the following occasions:

1. Saving on interest payments

With the fall in the interest rates, home loan rates have become cheaper than ever. If you had taken fixed loans at a high-interest rate in the past and your existing lender doesn’t allow a switch to a floating rate, it makes sense to do the switch. Also, if your existing lender continues to charge a higher rate, then you can switch to a cheaper fixed or floating-rate loan. 

However, be aware that there are switching-related costs. Some lenders charge two per cent of the loan outstanding as a penalty, while the new lender, in addition, charges for reprocessing your loan (about 0.5% of the loan amount) along with other miscellaneous ones. 

So, do the math to figure out, if switching the loan makes sense. 

Suppose, you have a Rs 50 lakh loan outstanding and contemplate shifting from a 10 per cent loan to an 8 per cent loan. By doing so, you will save interest equivalent to Rs 10.7 lakh over a 15-year period. However, by switching, you will also incur an additional cost of Rs 1.25 lakh (2.5% of outstanding). If this amount were instead saved and invested in equities it could have potentially grown (at 10% p.a) to Rs 5.2 lakh over the same period. Nevertheless, you still end up saving Rs 5.5 lakh by switching to a cheaper loan. 

Consider loan refinancing only if you are able to find a new lender cheaper by at least 1 per cent. Moreover, switch during the early stage of the loan when interest payments are a bigger component of your EMIs. 

2. Extend loans to lower EMIs

While the above bargain-hunting process can reduce your EMI by about Rs 6,000 (from Rs 53,730 to Rs 47,783) you can save more by extending your loan tenures. 

Supposing five years back, you opted for a Rs 50 lakh loan at 10 per cent for a tenure of 15 years and the current outstanding is Rs 40.7 lakh. By switching to a new lender at 10 per cent, you can take a new loan (equivalent to current outstanding) for another 15 years that ultimately reduce your EMI to Rs 43,692 (or cheaper by Rs 10,000). The existing lender usually desists from extending a loan.

While such refinancing provides temporary respite, it also adds up to your overall debt burden. 

Takeaway

Refinancing is a good option especially when market rates are cheaper by at least one per cent. However, be aware of switching costs and go for it only when the existing lender doesn’t budge.

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