How to Decide to Refinance an MCLR Home Loan – An In-Depth Analysis
If you’ve been running a marginal cost of lending (MCLR) home loan, the issue of refinancing it to a repo-linked loan might have been on your mind for some time now. Since RBI ordered banks to tie their loans to an external benchmark last October for faster transmission of the benefits of lower rates, most banks have introduced a repo-linked loan scheme. And since the central bank reduced the repo rate by 250 basis points since early 2019, these repo-like mortgage loans have seen record interest rates (some banks are currently offering loans from less than 7%). . Even MCLR loans have seen interest rate cuts, but the revisions have not been as deep and swift as their repo-linked counterparts.
So, should you go for refinancing now? You need to make an informed decision after carefully taking into account a number of critical considerations such as your loan amount, the difference in interest rates, the remaining term of the loan, your credit score, transfer fees. loan, among others. To help you, we’ve put together an in-depth analysis of a typical scenario and also shared some smart tips for maximizing the benefits of refinancing. We will take a look.
Case Study: A Borrower With A Rs 1 Crore MCLR Home Loan In 2016
Suppose Amit took out a home loan from a bank in July 2016. The loan related to MCLR is Rs 1 crore for 20 years at 9.45%. As of July 2020, his loan balance was around Rs 89.52 lakh. Its recent annual reset took its rate to 7.85%. He now has three options. One: refinance the loan with your bank for a better interest rate. Two: make a balance transfer to a new lender offering a lower rate than their bank. Three: do nothing. What should he do?
Let’s take a look at Amit’s loan repayment so far and how far we have to go after the last rate reset to 7.85%.
After 48 IME, Amit had only repaid Rs 10.47 lakh of its principal while the rest – around Rs 34 lakh – was interest. Its initial projected interest was Rs 1.22 crore. However, recent lending rate cuts have reduced Amit’s projected interest. Without the cuts, he would have had to pay around Rs 88 lakh more. After the recent reduction, he only needs to pay Rs 52.30 lakh more. As a result, Amit saved almost Rs 36 lakh without having to take action such as refinancing. So is doing nothing his best option? To find out, you have to calculate the benefits of refinancing.
To Refinance Or Not To Refinance?
Amit’s loan has an MCLR rate of 7.85%. His bank now offers a loan indexed to the repo at 7.40%, or 55 basis points less than its rate indexed to the MCLR. The difference is significant. Refinancing could therefore save Amit much more. Let’s look at the math.
Option 1 vs Option 2
Option # 1: Convert your loan into a repo-linked scheme with an interest rate of 7.40%. To benefit from the program, Amit has to pay a conversion fee of Rs 5,000. Amit had also applied to another bank, which made him an offer of 7.00% for a balance transfer to a loan linked to the repo. The fees are Rs 35,000. Let’s compare the results of each option in the table below.
Option 2 helps Amit save more
Amit decided to refinance his loan through a balance transfer to a new bank. Its rationale is simple: it saves him a lot more money over the life of the loan.
Switch flip: keep your old EMI
Amit chose to refinance his loan with a new bank. However, instead of going for a lower IME of Rs 88,098, he decides to continue paying a higher IME. He voluntarily rounds his new EMI to Rs 100,000. This will speed up the repayment of his loan, save him an additional Rs 8.90 lakh and help him close his loan in 126 months instead of 153, as shown in the table below. below.
Amit transfers its loan to a new lender offering a rate 85 basis points lower than its current rate. He follows the Switch Hit plan and voluntarily increases his EMI to Rs 1 lakh. This allows him to close his loan over 14-15 years instead of 20. His remaining interest falls to Rs 36.89 lakh against Rs 52.30 lakh earlier. He would therefore save Rs 15.41 lakh on interest if he decided to refinance – a more profitable option than doing nothing. It could take Rs. 68,000 annual investments in PPF for 13 years (at 7.1% per annum) or a SIP of Rs 4,100 in a 12% growth equity fund to build a fund of Rs 15.41 lakh .
Some key points to consider before finalizing your refinance:
The difference in interest rates: Only consider refinancing your loan if there is a substantial difference in interest rates.
Credit score: Repo loans generally consist of a client risk spread. If your credit score is below 750, you may not be eligible for the best rate. In addition, you must maintain a good credit rating throughout the life of your loan to continue to enjoy the lowest possible rates.
Remaining term of the loan: Refinancing your MCLR loan towards the end of your loan term may not result in substantial savings on interest payments.
Cost of refinancing and ease of transfer: Always factor refinancing fees such as processing fees and loan transfer fees into your calculations. Also consider the ease of transfer in terms of additional paperwork among other formalities.
Prepayment: Whatever your loan scheme, always try to make adequate prepayments when the applicable interest rate is low in order to reduce your loan burden and free yourself from debt faster.
(The author is CEO, BankBazaar.com)