Thursday, 29 October 2015

Has rate cut reduced your home loan EMI?

After the Reserve Bank of India’s 50 basis points (bps) repo rate cut , in the past 10 days, almost all major commercial banks have cut their base rate. One basis point is one-hundredth of a percentage point. Base rate is the minimum lending rate below which banks can’t lend to a customer. The base rate cut has been in the range of 20-40 bps.


Though Andhra Bank was the first to cut the base rate after the RBI monetary policy announcement, the rate cuts picked up pace after the country’s largest lender, State Bank of India (SBI), cut its rate by 40 bps to 9.3% from 9.7% per annum. Currently, almost all the major banks offer base rate below 10% per annum. For instance, SBI’s base rate is at 9.30%, the lowest in the industry followed by ICICI Bank Ltd and HDFC Bank Ltd at 9.35% per annum. Last year during the same period, base rates of all major banks was in the range of 10-10.25% per annum.
Impact on home loans
This week banks revised their home loan rates wherein some have increased the spread. A spread on a home loans is basically a premium charged above the base rate and it varies from bank to bank.
In a high interest rate regime, banks were offering home loans even at the base rate. For instance, when SBI’s base rate was 9.85%, home loans were offered at the same rate for women customers. However, last week after it cut its base rate to 9.3%, the interest rate on home loans came down to 9.50-9.55% because the bank increased the spread between the base rate and home loan rate to 20-25 bps.
Mint takes a look at the impact of the rate cut and subsequent increase in spread for those who have taken home loans on a floating rate.

New borrowers
The interest rates offered are better than what it was in the past couple of years. For instance, SBI now offers an interest rate of 9.55% to salaried individuals compared with 10.15% during the same period last year. Hence, the monthly instalments (EMI) on a home loan of Rs.50 lakh with an interest rate of 10.15% and a tenure of 20 years will fall by around Rs.1,980 per month if the lending rate is cut by 60 bps to 9.55%.
But before you jump at the first sight of a lower interest rate, do keep in mind that interest rate is not the only parameter to consider before opting for a loan. Do shop around and compare the interest rates of other lenders. Don’t only look at the base rate; factor in the spread on the home loan. You should know that when a bank says that its base rate is 9.3%, it does not mean that it is the rate at which you will get a home loan.
Along with the interest rate, you should also factor in other costs associated with a home loan. These costs include processing charges, documentation charges, commitment fee, inspection of document charges and stamp duty cost. Processing charge is typically 0.25-0.50% of the loan amount which is generally non-refundable even if your loan application is rejected. Also most of the other charges are negotiable.
Existing borrowers
For an existing borrower, the interest rate on home loan comes down if there is a drop in the base rate. And generally the spread on the home loan remains the same. “The interest rate and spread on home loan for our home loan customers is not uniform and varies depending on when the customer took the loan. In a higher base rate regime, we had reduced the spread. There are customers who now continue to get loans on the base rate and some on a lower spread because as per the contract it remains unchanged. So, some of our existing customers are getting lower interest rates on home loans than new borrowers,” said Jayanthi Lakshmi, chief general manager-real estate, habitat and housing development, SBI.
Most home loan agreement have a clause that they can change the spread. “However, banks do not usually change it,” said Manoj Nagpal, chief executive officer, Outlook Asia Capital. The impact will be only on a small segment of borrowers, i.e those who took a loan in the past 12-18 months from these banks, he added. “These banks had reduced the spread during that period because they didn’t want to reduce base rate despite a repo rate cut,” said Nagpal. For others, rates may be higher than that given to a new borrower and it varies from bank to bank.
When rates come down, banks generally reduce the duration of the loan to pass on the rate cut instead of reducing the EMI outgo. Here you have the option to pick a longer tenure or a lower EMI. “In rupee terms, higher the EMI, the lower is the interest rate that you will eventually pay. The decision also depends on what you are comfortable and varies on case to case basis,” said Suresh Sadagopan, a Mumbai-based financial planner.
Should you switch?
You also have the option to switch the loan to a new lender. While switching to a new lender, interest rate is not the only thing that you should consider. Firstly, compare the interest rate. And while factoring in the interest rate, calculate the remaining tenure of the loan.
“If the home loan is in the initial year of repayment and you have a longer tenure remaining, switching is likely to be more lucrative as compared with switching the loan when the end of the tenure is approaching,” said Sadagopan.
There are costs attached to switching your loan. These include foreclosure charges of the existing bank, prepayment charges of the new bank, nominal expenses of vetting the property, documentation cost, stamp duty and insurance cost.
You may also want to have a look at the lower rates offered by your existing lender. “Many customers don’t go through the new rates offered by their existing bank. Usually, a lender offers a new rate to its exisitng customer at a cost. Factor in this cost while calculating to see if it works for you,” said Nagpal.
Switching your home loan is similar to taking a new loan—you have to do your homework So, factor in the time and effort taken to switch to a new home loan.

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