Opt for home loan balance transfer or prepay to counter rising rates

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Interest rates are on their way up. The Reserve Bank of India (RBI) has delivered two successive rate hikes, taking the repo rate to 6.50 per cent. Last week the State Bank of India (SBI) hiked its retail deposit rates by 5-10 basis points (bps), so that its one-year fixed deposit rate now stands at 6.7 per cent. Several banks like Union, Kotak and Karnataka also hiked their marginal cost of funds based lending rates (MCLR) by 5-10 bps, which will push their home loan rates up. Both borrowers and depositors need to recalibrate their loan and deposit strategies to deal with this rising interest-rate environment.

Experts have two suggestions for home loan borrowers so that they are able to reduce the burden of their equated monthly instalments (EMIs): One is that they should opt for a home loan balance transfer (HLBT) and the other is to make part-prepayments on the principal amount.  

Transferring the home loan to another lender who is offering a lower interest rate will reduce the borrower's interest cost without affecting his disposable income and existing investments. However, opting for HLBT involves various charges like processing fees, administrative charges, etc. "Borrowers should calculate the net savings from the transfer by deducting those transfer-related costs from the savings generated on interest cost. If the net savings are substantial, they should go ahead with HLBT or else continue with their existing lenders," says Naveen Kukreja, chief executive officer and co-founder, Paisabazaar.com.

By making part-prepayments at regular intervals, the borrower can either continue with the same EMI at reduced tenure or he can reduce his EMI while continuing with the same tenure. "Opting for the former will lead to greater savings and faster repayment of the loan," says Kukreja. He adds that the borrower should not, however, sacrifice his emergency funds or financial corpus meant for crucial financial goals as doing so might impact his liquidity and force him to avail of costlier loans to meet those goals.

According to Mumbai-based financial planner Arnav Pandya, "The home loan borrower should compare the return he is earning on his investment vis-a-vis his loan rate. Only if the return on investment is lower than the home loan rate does it make sense to liquidate the investment to prepay the loan."

As for their deposit strategy, investors should opt for shorter-term fixed deposits now. "It looks like interest rates may continue to head upward for some time. Investing only a part of their money now will give depositors an opportunity to invest at a higher rate in the near future," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Another point that investors need to keep in mind whether they are investing now or later in fixed deposits is to ensure that their fixed deposits mature at different points in time. This is referred to as laddering. "If all the deposits mature at the same time, the investor will be subject to reinvestment risk," says Dhawan. This is the risk of an investor having to roll over his maturing fixed income instruments at low-interest rates. This can well happen if all the investments mature at the same point in time. On the other hand, if they mature at different points in time, the investor will be able to roll over his deposits at different rates.

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