Borrowing as a tool for wealth creation may sound surprising, but not when the loan comes at a very low interest rate and helps you build an appreciating asset or minimise high interest cost liabilities.
Since March 27, the Reserve Bank of India (RBI) has slashed the rate at which it lends to banks twice – 0.75 per cent in the first tranche and 0.40 per cent later – bringing down the repo rate to a historic low of 4 per cent, a level last touched 11 years ago during the 2009 recession. As a result of four reductions in the past one year, the home loan interest rate is less than 7 per cent. Not just new borrowers, existing ones, too, can benefit following the RBI’s mandate to banks to link rates to an external benchmark – either the repo rate (at which banks borrow from the RBI) or a treasury bill (a Government of India debt instrument) rate.
Good And Bad Loans
While this may be the best time to borrow if we go purely by the interest rate cycle, economic and job scenarios indicate that one must adopt a cautious approach. Consumers need to distinguish between money borrowed for pure consumption such as purchasing gadgets, renovation of home or other daily needs vis-a-vis a loans to create assets such as home or commercial property. “Asset-driven loans make more sense in the current scenario when there is higher level of uncertainty with respect to income,” says Gaurav Gupta, CEO, MyLoanCare.
While consumption-driven loans such as personal loans, gold loans and credit card debt come at a steep cost of 11-16 per cent per annum, asset creation loans have low interest rates, of less than 7 per cent. Plus, property prices are low. “This is the best time for first-time buyers to acquire a dream home for self-occupation if all other boxes in terms of eligibility are ticked. Property prices and interest rates have never been so low,” says Raj Khosla, Founder and Managing Director, MyMoneyMantra.
Emergencies such as accidents, illness, job losses may also force people to go for borrowing. In such a scenario, instead of an unsecured loan such as personal loan, gold loan or loan against financial securities, including bonds, FDs, stocks, mutual funds (MFs) or life insurance policy, is more attractive. Gold is the easiest to get a loan against. “Gold loan is easy to access. Banks are allowed to lend to up to 90 per cent of the value of gold. But one should avoid extending beyond 60-70 per cent of the value of jewellery, especially if you are self-employed,” says Khosla.
Dealing With Surplus
One needs to weigh the options well, not just while borrowing afresh, but also while dealing with an existing home loan and handling a surplus. Some options for existing home loans include partial pre-payment for EMI reduction, investing the surplus elsewhere for better returns, increasing EMI to reduce tenure, foreclosing an existing home loan or continuing a home loan for tax benefit.
But before using the surplus to make partial pre-payment of a home loan, one should look at other existing loans also. “If a borrower has a surplus, he should first repay loans with higher rates such as credit card debt, personal loan and auto loan instead of home loan that has the lowest rate of interest,” says Khosla.
Also, going by the current job scenario, borrowers are puzzled as to whether they should continue servicing a loan and invest the surplus elsewhere, or prepay loans and reduce EMIs.
If you think being debt-free is very important for peace of mind, go for pre-payment. Even those who wish to invest their surplus in bank FDs can go for pre-payments. Avoiding a 7 per cent home loan pre-payment and going for a bank deposit that is earning 5.5-6 per cent taxable interest is not a smart move. “If you are going to earn a return of 8-10 per cent or more by investing in a higher risk category, you should consider avoiding pre-payment and investing the surplus,” says MyLoanCare’s Gupta. Another option is to increase the EMI and reduce the term of the loan. This can be considered by those employed in sectors that have managed to brave the slowdown, including FMCG, IT and pharma. However, do not go overboard and keep the total EMI within 50 per cent of your monthly income, so that you retain the capacity to absorb minor income shocks.
Pre-Payment vs Tax Break
An individual who borrows for buying a house gets a deduction of up to Rs 1.5 lakh under Section 80 (C) for the principal amount. Additionally, home loan interest can help you save tax on income up to Rs 2 lakh, under Section 24 (B). An additional deduction for interest payments up to Rs 1,50,000 is available under Section 80EEA for affordable homes provided the borrower and the home both meet the conditions. Foreclosure or pre-payment can impact these tax benefits. But continuing a home loan just for tax benefit is not recommended either. Says Khosla: “If funds are available and I can reduce or square up the outstanding loan, then why should I have a liability? There are many other ways to plan your tax savings.” A home loan of Rs 20 lakh is sufficient to claim Rs 2 lakh interest per annum based on 7.5 per cent interest rate. The tax break on interest payment is capped Rs 2 lakh for non affordable houses. “It isn’t a rebate, but reduction in taxable income. So, you would save Rs 50,000-60,000 a year due to the taxation benefit. Those in the higher tax bracket can buy an affordable property with a smaller loan amount of Rs 15-20 lakh for the benefit” says Sukanya Kumar, Founder and Director, RetailLending.com.
Smart Saver Home Loans
A smart move is to opt for offset balance home loan accounts that have an overdraft facility. Interest is charged only on the outstanding amount. So, if you deposit surplus money, your outstanding comes down, followed by the interest amount. It also offers you flexibility to withdraw money when needed.
SBI offers such an account under the name of MaxGain, Standard Chartered calls it Home Saver, Axis Bank offers Super Saver Home Loans, HSBC calls it Smart Home Loans, while Union Bank offers it as Home Savings Account. In case of Citibank, for instance, the overdraft interest saved gets adjusted toward the principal and reduces the loan tenure. “You save money as you are charged interest only on the outstanding amount. Overdraft offers flexibility of availing tax benefit as well as parking surplus funds,” says Khosla.
Banks charge 0.5-1 per cent more for a loan overdraft account than a regular home loan account. The option suits those who have big sums lying in savings account. It reduces the outstanding and hence the interest cost.
Changing The Rate Regime
If your home loan is old and you have not shifted it to the latest system, chances are that you are paying a high interest rate. “There are people whose loans are linked to the base rate and they are paying a higher rate of interest because they haven’t asked their banks for a change. Banks haven’t taken the initiative of shifting customers from one system to another,” says Kumar of RetailLending.com.
In such a situation, you can shift the home loan to repo rate or treasury bill-linked rates, which follow external benchmarks. Whenever the RBI reduces interest rates, the rates under the new system fall faster than those on other types of loans. “If you have availed a home loan from a housing finance company, it will be based on the prime lending rate. If you want to shift that loan to a repo rate-linked rate, you need to do balance transfer,” suggests MyLoanCare’s Gupta.
Shifting The Loan
The most competitive home loan rates are between 6.75 per cent and 7.25 per cent. “If your current home loan rate is higher by 0.35 per cent or more, renegotiate the mortgage with the existing lender. If that doesn’t work, move your loan to a financer offering 6.9-7.10 per cent,” says Vipul Patel, CEO and Founder, Mortgage World.
However, before transferring the loan, calculate the net benefit, since you are likely to incur a cost in the form of processing fee and other charges. “State-specific stamp duty on a mortgage agreement eats into savings. For instance, in Maharashtra, one needs to pay a stamp duty of 0.2 per cent plus a fixed fee on a mortgage agreement. For a Rs 50-lakh loan, this would amount to Rs 15,000-16,000, which needs to be paid upfront,” suggests Gupta. This will not be sensible when you are trying to save money. Also, when you switch banks, do not fall for the zero per cent processing fee claims as equivalent legal and technical charges are involved, which will cost you Rs 2,500-10,000.
Home Loan Top-Up
A faster way to get funds at a lower cost without much documentation is to opt for a top-up loan on your home loan. The interest rate on this loan would be slightly higher than the home loan rate, but lesser than the rate on personal loan or credit card debt.
However, there is likely to be a checklist that banks would follow in the post-pandemic situation. “Right now, getting a top-up loan is going to be difficult because property prices have depreciated. A house that was valued at Rs 1 crore earlier has depreciated to Rs 80 lakh. Credit managers are not comfortable in giving top-up loans and valuation agencies are not ready to give the valuation. So, how far people would be eligible for a top-up loan is a big question,” says Kumar of RetailLending.com.
If your home equity has gone up over a period despite the correction, a top-up loan would be the best borrowing option. But if you are a credit defaulter or have opted for a moratorium, getting a bank loan will be difficult unless lenders are willing to ignore credit score issues. If you have gone for a moratorium or restructuring, chances are that lenders will be hesitant in extending further credit.
The author is a Mumbai-based writer