Here’s how you save on Home Loan Interest

What is a Home Loan?

Home Loan is a type of financial assistance availed from lenders such as banks or housing finance companies (HFC) for purchasing a house from a seller, or constructing a house independently.

As this loan is for usually a higher amount than a typical car or personal loan, this is granted by lenders after careful assessment of the applicant’s repayment capacity and, analysing the details of the property being bought. This loan has to be repaid over several years through monthly payments called Equated Monthly Instalments (EMI).

Interest on Home Loan

As the home loan repayment is generally spread over 10-30 years depending on the loan amount and repayment capacity of the buyer, the interest paid on this loan is higher than any retail loan in India.

Though the rate of interest is the lowest for a home loan, the total interest paid throughout the loan tenure is very high. This interest rate varies from bank to bank.

For a typical 20-year home loan at 8% interest rate, the total interest payable is the same as the principal amount. Thus, the buyer ends up repaying double the loan amount availed.

In some cases where the tenure is higher than 20 years, or the interest rate is higher, the total interest amount exceeds the principal amount.

Saving Interest on Home Loan

As home loan repayment has a higher interest component, here are some ways by which one can reduce the interest payable on home loan:

• Switching to MCLR based Home Loans:

MCLR stands for Marginal Cost of Funds-based Lending Rate. Under the MCLR option, the interest rates are based on the Repo rates and the bank’s cost of maintaining funds. As the Reserve Bank of India (RBI) revises the Repo rate as per macroeconomic conditions from time to time, the resultant MCLR is also revised in line with the Repo rate. Transferring existing Home Loans to MCLR based interest rate results in lesser interest rates than the home loans based on the bank’s Prime Lending Rate (PLR), or fixed rate of interest.

However, it is to be noted that only banks can offer MCLR based home loans. HFCs do not offer Home Loans based on MCLR as they do not come under the purview of the RBI. In India, HFCs are regulated by the National Housing Bank (NHB) and provide Home Loans based on their internal benchmark rates.

• Home Loan Pre-Payment:

Pre-paying a home refers to paying-off a Home Loan before its original tenure. This pre-payment can be either partial or full. As the pre-payment is done towards principal amount, the interest applicable on that amount for the remaining loan tenure is saved.

However, it is financially feasible to pre-pay a Home Loan during the initial years of the loan (around the first 5 years of a 20-year loan; and around 7-8 years for a 25-year loan) as the interest component is higher in the initial repayment tenure.

You may read here for more information on Home Loan Pre-payment.

• Increase EMI:

An increase in the EMI amount results in earlier repayment of the Home Loan than its original tenure. This in turn reduces the total interest payable throughout the tenure of the Home Loan. For instance, consider Ms. Shah taking a Rs. 30 lacs home loan at an 8% interest rate for 20-year tenure. The EMI amounts to Rs. 25,100. The total interest payable throughout the 20-year period is Rs. 30.2 lacs.

Now, after paying regular EMIs for 2 years, Ms. Shah requests her bank to increase the EMI by around Rs. 3,000 as per her increased income; to which, the bank agrees.

By paying a higher EMI, the remaining tenure of 18 years reduced to around 14.5 years (14 years and 6 months), and also saved around Rs.5.65 lacs of total interest payable.

It is highly advisable to increase the EMI amount every year as and when there is an increase in the documented income, based on the financial feasibility of the applicant.

However, it is at the discretion of the bank to allow any changes to the EMI amount or the total number of EMIs payable as per the applicant’s repayment capacity.

You may read here for more information on the impact of Home Loan EMI amount and tenure on the interest payable.

• Home Loan Transfer:

It is an arrangement where a home loan from an existing lender is taken over by some other bank. It is usually done when the lender taking over the loan has lower interest rate than the existing lender. So in this, the buyer pays off the outstanding principal amount of the home loan with his/her existing lender and takes a home loan with another lender whose interest rate is lesser than the existing lender.

However, the processing charges of the new lender, and takeover charges by the existing bank, as and where applicable should also be taken into consideration.