Home Loan Refinancing: When and how to refinance your home loan

Home refinancing involves paying off your existing home loan by taking off a new home loan with better terms such as a lower rate of interest.

Home loan interest rates have fallen to historic lows in 2021. At the start of September 2019, for instance, the lowest home loan rates were around 8.40%, and as of July 2021, the lowest home loan rates on offer are in the 6.49-6.95% range. The falling rates present homeowners an opportunity to increase their savings in times of the pandemic by refinancing their loans, according to BankBazaar whitepaper titled ‘Home Loan Refinancing in 2021’.

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Refinancing to schemes homeowners are eligible for could help them enjoy lower interest payments, smaller EMIs, and shorter loan tenures, which allows them to get out of debt sooner. Today, new borrowers can automatically avail loans at low rates from leading lenders. But in some cases, borrowers with home loans taken before October 2019 may be paying higher rates.

This increases their overall cost of borrowing and, therefore, makes it necessary to evaluate the important question: should they refinance their home loan? Refinancing could save homeowners lakhs of rupees. Here’s how:

What Is Home Loan Refinancing?

Home refinancing involves paying off your existing home loan by taking off a new home loan with better terms such as a lower rate of interest. The new loan can be taken either with the same lender or a new lender. The old loan is closed off. The borrower can start payments on the new loan. A loan with friendlier payment terms will help the borrower increase long-term savings on interest.

For example, a loan of Rs 50 lakh at 8.00% for 20 years attracts interest of Rs 50.37 lakh. If this loan is refinanced at 7.00%, the interest falls to Rs 43.03 lakh, ensuring savings of nearly Rs 7 lakh, which can be used for savings, investments, and the achievement of various aspirations such as travel, vehicle upgrade, or higher education.

When You Should Refinance Your Loan

Timing the refinancing well makes a big difference to your loan payments. Here are the situations under which it makes sense to refinance.

WHEN THERE’S TIME LEFT ON YOUR LOAN: Refinancing early in your loan tenure – typically in the first half – makes more sense. During this time, your EMIs focus mostly on interest payments. Therefore, a refinanced loan at a lower interest rate will lead to savings.

WHEN YOU GET LOWER INTEREST RATES: Often the biggest part of home ownership cost is the interest on the home loan. A loan cheaper by around 50 basis points or more could lead to a shorter loan tenure, lower EMIs, lower interest payments, and large long-term savings.

WHEN YOUR CREDIT SCORE & INCOME IMPROVE: An improvement in your credit score (750 or above) as well as income stability will allow you to access the best loan offers.

WHEN COSTS OF REFINANCING JUSTIFY IT: Refinancing has a cost. When the projected savings from refinancing exceed the costs, you should consider refinancing.

WHEN YOU’RE GETTING BETTER SERVICE: Digitised account management, on-tap customer service, proximity to branch, lower costs of account management coupled with the above-mentioned reasons, make for a compelling case for refinancing.

Who Should Refinance?

Home loans are refinanced for many reasons, some of which are enumerated below.

BORROWERS ELIGIBLE FOR LOWER RATES: Your current loan rate may be much higher compared to what’s been offered today.

BORROWERS WITH HIGH CREDIT SCORES: If your credit score has improved and is over 750, you may be eligible for better loan offers.

BORROWERS LOOKING FOR BETTER BENCHMARK: Repo-linked bank loans have become the preferred choice of customers with good income and credit profiles. Repo-linked loans are more transparently priced, helping borrowers assess when and by how much their floating rates will rise or fall.

BORROWERS LOOKING FOR SMALLER EMIS OR LONGER TENURE: A refinanced loan could help you pay a lower EMI due to the lower rate. It could also increase your loan tenure, making it easier for you to repay the loan.

BORROWERS NEEDING EASIER PAYMENT TERMS: Terms and conditions could drive up costs of borrowing – for example, being asked to pre-pay a minimum of 2X your EMI instead of 1X drives up interest.

BORROWERS NEEDING BETTER CUSTOMER SERVICE: Digitised services, on-tap account management, a responsive relationship manager, and proximity to the branch make things easier for the borrower, especially in a pandemic.

LANDLORDS LOOKING FOR HIGHER RENTAL YIELDS: A cheaper loan could help improve the rental yield from your under-loan property.

How To Refinance

Step 1: Check if your loan is competitively priced and offers you the quality of service you need. If so, you don’t need to refinance. Let’s label the interest you pay hereon ‘A’.

Step 2: If your own lender is offering a rate lower than what you’re paying, approach your lender and ask to be moved to the lower rate. This will involve paying a processing fee.

Step 3: Calculate your savings from Step 2. This would be interest saved minus costs of refinancing. Let’s call this ‘B’.

Step 4: If the lender does not offer you a competitive rate, approach another lender basis your credit and income profile. Ask for the lowest rate you can avail along with the costs of refinancing.

Step 5: Calculate savings from Step 4. Let’s call this ‘C’.

Step 6: Compare ‘A’, ‘B’ and ‘C’. The option that offers you the lowest interest and other desirable benefits is your go-to option.

LET’S UNDERSTAND THIS WITH AN EXAMPLE

You have a loan balance of Rs 25 lakh at 8% with nine years left on your loan. Your options:

A: Do nothing, remain with your current lender.
B: Seek refinancing to a lower rate with your current lender.
C: Seek refinancing to a lower rate to a new lender.

Here’s the math.

Net savings calculated as interest saved over Option A (Rs. 10.15 lakh) minus new interest minus costs of refinancing. Savings Percentage is Net Savings as a percentage of interest paid in Option A.

The above example shows that despite the same rate being offered in Options ‘B’ and ‘C’, there are higher refinancing costs in ‘C’, which makes ‘B’ the preferable option.