Home Loan: Calculate refinancing costs when deciding between loan conversion and balance transfer

Older loans linked to previous benchmarks have got cheaper but at a slower pace.

Home loan rates have fallen to a historic low. As of mid-July, at least 10 lenders including private ones were providing home loans at rates less than 7%. One government bank pegged its lowest rate at 6.70% for eligible borrowers. So, is your current rate competitive? If not, should you refinance? What’s the process? Let’s examine home refinancing in greater detail.

Loan benchmarks

Every loan is linked to an interest rate benchmark—the lowest rate at which the loan can be given. The lowest rates are typically reserved for salaried borrowers with high credit scores. Today, there exist several lending benchmarks such as base rate, prime lending rate and MCLR along with the newest benchmark—repo-linked rate.

The lowest home loan rates today are on repo-linked loans. Older loans linked to previous benchmarks have got cheaper but at a slower pace. If you had taken a base rate loan in 2010 and never refinanced, you may be paying close to 9% though you are eligible for 7%. A 100-200 basis point reduction could save you lakhs of rupees over the remaining tenure of your loan.

Loan conversion

If you’ve taken a bank loan linked to an older benchmark, chances are that your interest rate is higher compared to repo-linked loans. You can ask your bank to convert your MCLR or base rate loan to a repo loan. This will involve paying a conversion fee. Only banks provide repo-linked loans while HFCs link to the prime lending rate. Despite the ease of conversion and limited paperwork, the flipside of remaining with your lender is that you’ll have to accept the lowest rate being provided.

Balance transfer

With a loan balance transfer, you pay your ongoing home loan and start a new loan. This option is availed when another lender gives you an appreciably better deal. A fresh loan would normally entail processing charges and Memorandum of deposit of title deed charges which will vary from lender to lender. A balance transfer could be pricier and involve a lot more paperwork compared to a loan conversion. However, you’re doing this because, despite the upfront costs, this deal could save you more money in the long run.

How to evaluate costs

Assume you have a loan balance of Rs 30 lakh at 8.50% with 10 years left. This is Option 1: Do nothing, continue your payments, and your interest will be Rs 14.63 lakh. Option 2: Convert to a repo loan being offered by your bank at 7.3% with a charge of Rs 5,000. The projected interest: Rs 12.35 lakh, which saves Rs 2.28 lakh (let’s call this ‘A’) over Option 1. Option 3: A balance transfer to another lender offering you 7% with a charge of Rs 30,000. Your interest will be Rs 11.79 lakh, which saves you Rs 2.84 lakh (‘B’) over Option 1.

However, let’s also look at refinancing costs and their future values. Compounding the costs at 7% over 10 years, Option 2 costs Rs 9,835 (let’s call this ‘A1’), and Option 3 costsRs 59,014 (‘B1’). Now, A minus A1 is Rs 2.18 lakh, and B minus B1 is Rs 2.25 lakh. The interest rate difference between the two options is sizable; however, your net gains are negligible: about Rs 7,000 saved over 10 years, or Rs 58 a month. You could, therefore, consider Option 2: a simple loan conversion which is cheaper, faster, and involves very little paperwork.

The writer is CEO, BankBazaar.com