What lies beyond the teaser rate?

First of all,remember that these recently announced low rates are only for new loans,and not for existing loans. But whether you are a fresh borrower or an existing one,you want to take advantage of the new lower-rate environment. So let’s take each of these two cases starting with existing borrowers.

If you are an existing borrower

If you took a home loan in the last few years,chances are that you pay a rate close to 10 per cent. Now that rates have fallen to close to 8 per cent you are probably wondering what you can do to save money. Most rational people would like to “refinance” their more expensive home loan to something cheaper,as long as it makes economic sense to do so,i.e.,the cost of the refinance is not expensive.

This process of refinance is known as balance transfer — you transfer your outstanding home loan balance from one lender to another. The way it works is that the new lender pays your old lender the money outstanding on your loan. Your obligation for repaying the outstanding amount is now towards the new lender.

The two most common reasons for a balance transfer are to lower your interest payments to the lender,or to change the terms of your loan,such as to extend the loan tenure. You can also use refinancing as an opportunity to get a top-up loan equivalent to the amount already repaid and on the increased value of your home.

Is there a cost involved? Contrary to your incentive to save money through refinancing,your existing lender has no incentive to transfer the loan to another bank. So this lender will create some hurdles for you by requiring you to continue with the loan for a minimum period. Check with your lender if you have met this hurdle or not.

Additionally,the existing lender might charge you a penalty,which could be anywhere between 2-4 per cent of the outstanding principal amount of the loan at the time of refinancing.

Finally,the new lender that you are going to go to might charge you a loan processing fee (plus service tax) of anywhere between a minimum of Rs 5,000 to a maximum of 1 per cent of the loan amount (depending upon whether you are self-employed or an employee).

If you are a new borrower

If you are in the market for a fresh home loan or are a first-time borrower,the “teaser” rate of 8 per cent probably looks tempting. But before you blindly jump into these loans,understand how they work.

To start with,remember that the announced rate is a teaser rate for an initial period,usually three years. During this initial period,the rate moves up by about 0.5 per cent every year. Then around the fourth-year mark,the loan gets further adjusted depending upon the then prevailing in-house rate of interest that the bank prices all other loans at. The technical term for this in-house rate is Prime Lending Rate (PLR).

For example,for loans between Rs 5 to Rs 50 lakh,the lender might charge 8 per cent in year one,and 8.5 per cent in years two and three. From year four the borrower can choose between a floating rate which is 2.75 percentage points below the bank’s in-house rate and a fixed rate which is 1.25 percentage points below this in-house rate. There is no way of knowing today what the in-house rate will be a few years from now,because this rate is set internally by the bank. It’s quite possible that the rate could reset to around 10 per cent.

So,what you need to watch out for is whether you will be able to afford your EMI payments even after the rate resets to a higher level after the initial teaser period. Ask your home loan advisor to show you a worksheet with scenarios of how your EMI payments might change once the reset occurs.

Points to remember

Whether you are an existing or a new borrower,here are a few things you must keep in mind:

•Understand the long-term implications. Home loans are long-term borrowings,often with a tenure of up to 10-20 years. So what you should really be thinking about is if you are going to be better off in the long-term,and not just in the first year. Can you afford all the payments during the entire duration of the loan? Other banks might be offering you a home loan rate where the average rate across the tenure of the loan might be as cheap.

•Do you understand what the Prime Lending Rate is (PLR)? Every bank has an internal interest rate according which all other loan rates are priced. The bank has full discretion to set this rate. Ask your lender to explain to you how the bank’s PLR might fluctuate and how these changes might affect you.

•Penalty for balance transfer.

When you get a loan with a low initial rate,your flexibility is likely to be restricted. This can hurt you if and when you need to re-finance your loan with another lender that might offer you better terms in the future. Understand if there will be a penalty for balance transfer and whether you will be allowed to transfer your balance at all. Could the penalty fees be so high that it offsets any benefit you may have enjoyed by taking a home loan with a cheap teaser rate? Understand how flexible your lender is going to be.

•Processing headaches and customer service. Understand from well what kind of customer service you can expect from your lender. We have seen enough clients go for cheap teaser rates from banks,only to suffer because either the file is not processed on time or the disbursement is delayed. Ask older customers how their experience with the bank has been.

Getting a home loan is a time-consuming process. You are also entering into a very long relationship with the bank. With a little bit of caution,you can ensure that you get a good deal. u

The authors are co-founders of Gurgaon-based iTrust Financial Advisors (www.iTrust.in)