Balance transfer of housing loan – an opportunity

Real estate is among the most complex asset classes and can have an asymmetric payoff during good times. Besides, pride of ownership, buying a house is also seen as one of the most effective ways to make money. Stories of multiplying money and/or lost investment opportunities in dream projects abound.

A good price appreciation on your property is the biggest opportunity to gain, by far. Additionally, you can save on taxes, on interest repayments on an ongoing basis.

On the other hand, it’s fairly common to have people think of money paid on rent as wasted money and hence ownership allows you to ‘save’ that.

After having a dream run for over a decade, residential property prices hit a rough patch over the last couple of years, stagnating in most top cities mainly due to a combination of factors such as plenty of supply, high interest rates on home loans and slower economic growth.

And, people don’t seem very sanguine about the near future either. In a study of over 5,000 people, across 7 cities in India, between 60% and 80% of them expect an under 10% appreciation per annum in property prices for the foreseeable future. This is lower than the cost of the loan.

As the price slump continues, a bit of rethinking is in order. Does it really make sense to invest or even be holding onto a property? Should you be continuing with the existing home loan with a high rate of interest?

Some of our learnings from the same study:

1) At the stated expectations of price appreciation, it may take anywhere from 9 to 14 years for a purchase decision to pay off. If the consumer has a shorter time horizon than this, makes it advisable to rent the property.

2) With expectation of appreciation higher in smaller or tier 2 and 3 cities being higher than their metro counterparts, it might be advisable to rent a house in the city one works in (typically one of the larger cities) while buying a home as an asset in a smaller city, possibly even one’s hometown where it’s highly likely for prices to be lower (making a property more easily affordable) and expected appreciation higher. A better way to save would be to transfer your home loan to another lender at a reduced interest rate.

Ever since the RBI mandated that banks cannot charge pre-payment or foreclosure charges on variable (or floating) interest rate loans, switching to the lowest cost lender is a very real customer opportunity.

Please refer the following table to appreciate the opportunity:

On Rs 1-crore loan, you save more than Rs 80,000 per year if your interest rate is reduced by 1%. This will add up to a total saving worth Rs 16.12 lakh over the entire loan tenure (assuming it to be 20 years). How many opportunities to save this kind of money exist in today’s day and age?

Additionally, you can top up or borrow the “paid back” amount resulting in the cheapest possible personal or business loan. For example, if your home was valued at Rs. 70 lakh at the time of purchase with a loan of 80% of the value that is – Rs. 56 lakh, after 3 years, the price of the house might have become, say, Rs 80 lakh. At this point of time, if you opt for a refinance (loan transfer), considering the outstanding loan amount to be about Rs 53 lakh, the new lender would give you 80% of Rs 80 lakh (existing market price), which is Rs 64 lakh. Even after clearing the outstanding balance (Rs 53 lakh), you would be left with an extra cash of Rs 11 lakh. This money has a cost of 10% per annum. Given that most business or working capital loans come at rates ranging from 14 to 24%, money at 10% could be hugely beneficial.

Mathematically speaking though, the ideal way to save the most amount of money, is to prepay a certain portion and reduce the tenure of the loan. This reduces the interest burden while still giving the same amount of tax benefit. Essentially, the interest outflow is minimized by doing two things:

1) Reducing the amount owed to the lender

2) Reducing the amount of time the money is borrowed for.

Of course, EMI minimization cannot be the goal in such cases. Often, reducing the tenure even at a lower interest rate might actually increase your EMI but if overall savings is the ultimate goal and you can afford to pay the increased EMI, it’s worth it.

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