Home Loan Queries

Buying a house is one of the biggest decisions in one’s life. Today with so many options available in the market, it is very difficult for a person to decide on which one to finalize. Same was the issue when I decided to purchase a flat. However on booking my flat I found it even more difficult to finalize on the bank for my housing loan. Like all the people, my task started with visiting all the banks personally, and discussions with my colleagues who already have a home loan. Initially I was stubborn to go with State Bank of India, as I was obsessed with the thought that private banks are all here to cheat and SBI being the best nationalized bank I should go with it.

After considering several options I came across an innovative product called the Interest Saver a.k.a Offset Loans. And you won’t believe me, but with this product and proper planning I discovered that I can save Rs9,00,000 on my over all interest cost as compared to traditional floating rate housing loans. But surprisingly I didn’t see any bank executives publicizing this product much, and hence thought of writing this blog. I first discuss some criteria’s that one should consider before going for a housing loan, and then I discuss in detail on what is this interest saver loan and how you save on the interest rates. Also provided is the link to download excel sheet with all calculations to see the impact yourself.

As home loan is a long term commitment unlike vehicle or personal loans these are a few criteria’s that I think everyone should consider before deciding on the bank to go with for home loans:

1. Structuring of Interest Rate

Firstly, consider how the rate of interest is calculated. Now RBI has issued a guideline for all the banks to distribute loans on the Base Rate mechanism, however there are still some banks that continue to follow the old Prime Lending Rate (PLR) system. So what is the difference between the 2 mechanisms? Base Rate system is a slightly upgraded system over the PLR system. Under the PLR system banks determine their PLR depending upon RBI’s decision to raise or lower the prevailing interest rates and then a markup to determine the interest rates. Say for instance the PLR of a bank is 12% and the markup is 2.75% then the rate of interest (ROI) on your home loan is 12 – 2.75 = 9.25%. Same logic is for Base Rate which is determined on the basis of cost of funds for the banks, just that here we add the markup on base rate. Say for instance the same bank has a Base Rate of 7.5% and a markup on base rate is 1.75%, so your ROI comes to 7.5+1.75 = 9.25%. Now all the banks used to grant home loans on a PLR system earlier, but now they have to move to the base rate mechanism. Here’s how the catch works, it has been a policy of all the banks to lure new customers by offering less ROI as compared to what its existing customers are paying. To gauge this simply ask anyone who took a home loan couple of years back, and compare it with the prevailing rates of the same bank. My boss has a home loan from SBI which he took 6 years back, today he is paying 10.5% ROI however even if we forget the teaser rates SBI’s prevailing rate is 9.25% for new customers. Now recently SBI increased its PLR by 0.25 % but the base rate only by 0.10%. So, the ROI for existing customers will increase more than what it will be for the new customers. So it is always beneficial to go under the upgraded system.

2. Markup on the Base Rate:

Before I discuss this, I think it is necessary to discuss on how the banks have responded to increase in the interest rates historically. Earlier under the PLR system, when interest rates used to go up, banks used to increase the PLR and hence the ROI immediately, however if the interest rates come down they won’t bring down their PLR immediately or to the same extent. In order to remain competitive they will increase the markup, so the ROI is less for new customers but the same or little more than this for the existing customers. For e.g. if a bank has PLR of 13% and a markup of 3%, so the ROI is 10%. Now if the interest rates come down by 1%, the banks won’t bring down the PLR by 1%, but will increase the markup to 4% from 3%. So the ROI applicable to new customers is 9% however for existing customers it continues to be 10%.

So, not necessary but I personally feel that markup should be an important criteria that you should consider. Suppose that Bank A has a base rate of 7.5% but a markup of 1.75 % and a bank B has a base rate of 8.5% and a markup of 0.75%. So the present ROI applicable is 9.25% for both banks. Now after several years say the base rate for both the banks go up by 2%. So the applicable ROI for existing customers would be 11.25%. As per the RBI guideline banks cannot lend to any customer at an ROI of less than the base rate. So to lure new customers banks can decrease the markup than bringing down the base rate when the interest rates fall. Now Bank A has a markup of 1.75% but Bank B has a markup of only 0.75%. So Bank A has more scope to reduce the markup to lure new customers by keeping the Base Rate same as compared to Bank B. Bank B in order to remain competitive will have to reduce the base rate and the existing customers will also enjoy the benefit of reduced interest rates.

3. Disbursement Terms:

Not everyone buy a fully constructed apartment, where the bank has to disburse the entire amount at one time. For under construction apartments amount is demanded and accordingly disbursed by the bank in installments depending on the terms of the agreement with the builder. Generally the installments are linked to the roof slabs of different floors, as and when the construction of the building progresses the payment needs to be disbursed. Builders generally give 7 to 10 days of time to make payment after raising the demand note, failing which they charge high interest like 18%. Once you give the demand note to the bank, they carry out an inspection at the site to check if the property has been constructed up to the level as specified in the Agreement of Construction, and then disburse the amount.

So if you are going for an under construction flat make sure that the processes of the bank are fast enough to disburse the installments on time.

4. Processing Fees:

Compare the processing fees with several banks, and also check if the bank that you have finalized already financed loan for someone in the same project. In this case you have a better negotiating power for the processing fees, also try dealing with the banks directly rather than dealing with the 3^rdparty organization that are on contract with the bank. If you deal directly with the bank there are better chances that they will reduce the processing fees than if you deal with an agent, as part of the processing fees goes to the agent. I took a loan through a third party and had to pay a processing fee of Rs. 15,000 however, I soon discovered that if I had dealt with the branch directly they would have charged me a processing fee of Rs. 10,000.

5. Other Parameters:

Other parameters to consider are the prepayment penalty, whether the interest is calculated on daily or monthly reducing balance. Private Banks generally calculate interest on monthly reducing balance while nationalized banks calculate the same on daily reducing balance.

Let’s talk about Interest Saver also known as Offset Home Loans:

1. What is it?

Interest Saver Loans a.k.a Offset Home Loans are meant for people who can do some periodic savings apart from regular expenses. It is simply a normal home loan along with which bank will open a current account which is linked to your loan. The outstanding principal on which interest is calculated is reduced by the amount you maintain in the current account. So the interest portion in your EMI is reduced and you payback more of your principal, in financial terms your outstanding principal reduces more.

2. Is there any catch here?

The common question which arises in everybody’s mind is why banks would offer this benefit to us, is there any catch in this. Well yes, interest saver loans do not come free. Banks generally charge an extra interest rate as compared to normal floating rate loans. I have gone for this loan with IDBI bank and it charges 0.5% extra. So for normal floating loans the ROI is Base Rate + 0.75% and for Interest saver it is Base Rate + 1.25%, all other terms are the same.

3. An example to show the savings:

I have gone for a loan of Rs 30,00,000 so I have prepared an amortization schedule for this amount based on the terms of IDBI. So presently ROI applicable to me in Interest saver would be 9.75% whereas for normal floating rate loan it would be 9.25%. Firstly if I do the calculation for normal floating rate loan for 20yrs at 9.25% my total interest cost comes to Rs35,94,241 and I repay my loan in 20yrs with EMI of Rs. 27,476. Now for Interest saver loan, for 20 year term my EMI comes to Rs 28,456 and I assume that every month I’ll deposit Rs10,000 in my current account linked to the loan account apart from paying the regular EMIs. Here my total interest cost comes to Rs.17,57,268. But this is not the only cost. The Rs10,000 that I deposit in the current account every month, if I open a recurring deposit I’ll gain some interest on it, which I have to forego over here(I assume an ROI of 7% for this) and call it opportunity cost which totals to Rs.9,40,121. So my total cost under interest saver option is Rs.26,97,389 thus I save Rs8,96,852 over the interest cost as compared to normal loans plus I repay my entire loan amount in just 14 years as compared to 20 years in normal floating scheme. Moreover, it’s only for the 10 years that I have to pay interest and after that my entire EMI goes for the deduction of principal part only. So effectively we can say that I repay my loan in just 10 years.

4. What is its difference with prepayment?

An immediate question that comes to our mind is if I have extra cash why not just pay it to the bank rather than keeping it in an extra account. Well friends answer to this is simple but very important. Life is full of uncertainties, today you have money but the need for the same may come tomorrow. If you pre pay the loan, you cannot get the amount back if you need it in future, but if you maintain it in the interest saver account, you can withdraw it at any time whenever you need it. Moreover just imagine if you pre pay the loan now and later when you need it you’ll have to go for a personal loan, the ROI for the same is much higher than for a home loan which you still enjoy in the interest saver option.

5. What are the things to look out for?

Well generally the other terms and conditions are same with Interest Saver and normal floating loans. I would strongly recommend going with the banks that do interest calculation on a daily reducing balance system than a monthly reducing method. Under daily reducing method, your interest liability would come down from the very same day you make a deposit in the interest saver account. Also the effective method which I myself plan to follow is to transfer your entire salary to your loan account as you get it. As you’ll get a debit card for the same account you can withdraw funds to meet your expenses as and when required. This will be effective only under the daily reducing balance method.

6. Who am I, and should you blindly trust my calculations?

Well I am a consumer like you all and not an agent of IDBI or any other bank. I am not forcing you to go with IDBI, in fact if you get better offers from other bank please go ahead and share with me. Regarding my calculations, being a mathematics and finance graduate I would say strictly do not completely trust someone else’s calculations. Hence I am providing you the link from where you can download the excel sheet below. You can change the parameters like loan amount, interest rate, and additional markup for interest saver options and ROI for recurring deposits to suit your needs. Input parameters are highlighted in green, then simply put you excel in automatic mode or press F9 for the calculations and see the savings. If you find any error in my calculations please highlight it to me, I’ll rectify the same.