Avoid extending the tenure of your home loan. It's always wiser to pay higher EMIs instead
This is not the best time for home loan borrowers. Banks are hiking home loan rates and the spate of hikes just doesn't seem to be coming to an end. If you have been a prudential borrower and kept home loan EMIs under 40% of your take home salary, you still have some breathing space. But the over-leveraged borrowers, who's EMIs are nothing less than 65% of the take-home salary, have more than one reason to worry. With bankers speculating another round of rate hikes, it is time to do some math and work out a plan.
Keep Investing
Banks cap your EMI at 50% of your take-home salary, on the highest side. Ideally, you borrow only up to 40% of your take-home salary so that you can also build enough savings over a period of time. Stick to a monthly investment option to park your surplus cash.
Use a SIP to build a sizeable corpus over a period of time. You could open a recurring deposit with a bank or a post office. In case of banks, you can earn a return of around 6% but you have the flexibility in choosing the tenure of the recurring deposit. The post office, on the other hand offers 8% on RDs but they come with a lock-in of five years. Alternatively, you could look at SIPs in debt funds if you are looking at a term of 3-4 years. For anything beyond five years, you could look at SIPs in equity-oriented mutual funds. Unlike an RD, a borrower can stop his SIP half way if he is unable to cough up the money. But you should strictly look at SIPs on debt products and liquid-plus categories. Similarly, you can earmark a part of your bonus or the entire bonus for part prepayment of the principal. This will lower your interest costs substantially. However, use the entire bonus towards the home loan repayment only after meeting the expenses and investment needs for long-term financial goals. The logic is that home loan is a good debt because it's used in creating an asset plus you get tax benefits on the loan. Also, your old investments could come in handy when you are cash-strapped. But the rule of thumb is to never liquidate your investments completely to pay off the dues.
Ideally, an investor should use the profits from his investments to partly pay off the dues. For this, an investor should design an aggressive investment strategy, which is predominantly equity. Once he sets into this strategy and follows the profit-paying model, he may even be able to pay off the entire dues by two-thirds of the tenure.
Before Increase The Tenure
This is the worst and the last option a borrower should avail. When-ever a bank increases the home loan rates, a borrower can factor in the hike by either paying a higher EMI or increasing the loan tenure. Increasing the EMI is the best option. But what if you are walking on the tight rope and cannot foot the rise in EMI? If you are not in a position to service any more EMI that you are doing currently, then they can allow the tenure to increase but the interest cost will rise. For example, let's assume you had taken a home loan of 25 lakh on January 1, 2006 for a 20-year term at an interest rate of 8.5% per annum. The EMI will work out to 21,696, which you would have paid regularly till date. If the interest rate is changed to 9.5% effective January 1, 2011, you will have two options at this stage. You can pay a higher EMI of 23,006, so that the loan can be fully repaid within the same period of time as defined under the old rate. Under the second option, the tenure will increase by 27 months. If you go for the second option, you have to pay an additional interest of 3,41,547. However, if you are confident that you are going to prepay at regular intervals, increasing the tenure can be considered as an option.
BEFORE YOU SWITCH LENDERS
Switching home lenders makes sense only if the new lender would charge 1-1.5% lower interest than the existing loan. Secondly, you should switch to another lender within the first 10 years of the repayment cycle given that you would have paid off a substantial component of interest payment in this time period. But switching the home lender comes with a certain cost. Refinancing of a home loan follows a three-fold charge structure. One of the main costs attached to balance transfer on home loans is the prepayment penalty with the existing lender, which can work to up to 2% of the total outstanding amount. Now, the caveat here is banks may waive off penalty on foreclosure of home loans, if it's funded out of your own savings. But if the prepayment is because you are switching home lenders, then your existing lender may slap a penalty. So before you decide to switch lenders read your home loan agreement and look if they have any clause on refinancing of home loans or balance transfer. Another cost attached to switching lenders is the processing fee to take over the loan. It can be around 0.50-1% of the total loan amount. Finally, your new lender may ask you to obtain a fresh set of no-objection certificates (NoCs), which may come at an additional cost. They may also ask you to create an equitable mortgage, which means additional stamp duty charges. You cannot buy a house without taking a housing loan given the sheer cost of real estate, especially in metros and larger towns. Further, it is a good loan as you are building an asset with the loan amount. But never let that loan amount bloat so much that the biggest asset of your life turns out to be a white elephant.
