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- Home Loan is the biggest & longest commitment that you will make in your life time and it is important that you spend some time & effort before deciding the bank from whom you take Home Loan
- Every bank has its own Base Lending Rate (BLR). BLR is the lowest rate of interest(ROI) at which a bank can give loan.
- Compare the BLR of each bank and the bank which has lowest BLR will be able to give home loan at lowest interest rate
- If the rate of interest on home loan is greater than the BLR of the bank,then you ask them why is it so and bargain to bring it as close as possible to the BLR.
- There are two options of interest rates for home loan
1.Fixed rate of interest - means rate of interest is fixed for first 3 or 5 years or for entire tenure
2.Floating rate of interest - means rate of interest changes frequently based on market condition
- Select fixed rate of interest,when the rate of interest offered by bank is low, say when it is 7 to 9%.But you should have in mind that rate of interest may increase 2-4% after 3 or 5 years based on terms & then market conditions
- Select floating rate of interest ,when the rate of interest offered by bank is high, say when it is 11% or 12%
- Ask questions related to various charges like processing fee, penalties, part payment & pre-closure conditions or charges and try to bargain & reduce wherever possible
- Compare the EMI per lakh of various bank for fixed term say 20 Years.The lowest EMI means lowest rate of interest
- The EMI per lakh also varies depending on whether bank calculates interest on daily reducing balance or monthly reducing balance.You will pay less interest if interest is calculated on daily reducing balance.
- Do not go with the bank which gives home loan based on it Prime Lending Rate (PLR) because PLR will be always greater that BLR and the rate of interest will be high
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- If you already have a home loan does not mean that you can keep on paying the EMI every month till the term ends.There are many things that you can do so that you pay lesser interest on your borrowed amount
- Try to make part payments every six months or one year especially in the initial 5 years.This will bring down your term drastically because your initial EMIs will have very tiny portion as principle say 5-10% rest all will be only interest
- Part payment is nothing but making payments apart from your monthly EMIs that gets reduced directly in the principle outstanding on your loan
- Making part payment of just Rs.50000/- every six months in first 2-3 years may bring your tenure down by 2-5 years depending on your ROI and tenure of your loan
- Other than the initial years, make part payments when ROI is high, say when it is around 12% and do not make part payment when ROI is low, say when it is around 7-8%
- Most of the banks do not chanrge anything for making part payments.Each bank will have its own partpayment rules on minimum amount and number of times part payment can be made in a financial year
- Even if you make minimum number of part payments in a year specified by your bank, you will save lot of interest especially if you make part payment in the initial years of your tenure
- Keep an eye on your rate of interest every quarter, request statement of accounts & repayment schedule every quarter or half yearly
- Compare the statements and repayment schedules of previous quarters and ensure that your payments are reflected in them as expected,if not call the bank and get it corrected
- Keep sufficient balance in your bank account for ECS or cheques to avoid penalties or extra charges
- Keep an eye on current interest rate on home loan from other banks,if the difference in ROI is more than 2% when compared with your bank, then you can go for switching the bank
- Before going for switching loan to other banks consider additional charges or penalties to be incurred to switch to other bank.Then make the decision.
Let us understand these basisusig conversation beweer our two common man charecters Kallanna and Mallanna
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- Kallanna - I have heard recently that RBI Governer has reduced Repo Rate by 50 basis points and everyone is saying that this is good for the market. Loan EMI may also come down. What is this rate cut means actually? I want to understand this.
- Mallanna - To understand this you first need to know, how does a bank function.
- Kallanna - Why?
- Mallanna - Because all these are inter-related. Tell me – what does a bank do?
- Kallanna - Bank takes money from depositors and gives loan to earn interest. That way they keep everyone happy and make a profit also.
- Mallanna - Correct, but there are more to it. Let me explain this in a very simplistic way. Bank needs money. Bank can get money from depositors like you and me and also from RBI. But bank also needs to pay certain interest to us and also to RBI.
- Kallanna - Ok.
- Mallanna - Let us try to understand first – what happens when we deposit, say, Rs. 100 with a bank.
- Kallanna - I know that. Bank gives that Rs. 100 to someone who needs a loan.
- Mallanna - No, it is not that simple. Remember, though bank can earn interest by giving away loans, but it is also very risky. There are many cases of loan defaults. This way banks can put all our money into high risk areas. It has to be protected.
- Kallanna - How?
- Mallanna - Ok, RBI has made it mandatory that upon receiving, say, Rs. 100 – banks first have to deposit Rs. 4 with RBI. RBI keeps this Rs. 4 in its current a/c and hence banks do not receive any interest on this money. This is known as Cash Reserve Ratio or CRR,
- Kallanna - Hmmm, then?
- Mallanna - RBI has also made it mandatory that upon receiving, say, Rs. 100 – banks need to compulsorily buy central and state govt. securities of Rs. 21.50. Of course banks will earn some interest income here. This is known as Statutory Liquidity Ratio (SLR), which is currently at 21.50%.
- Kallanna - Ok, so you mean to say that upon receiving Rs. 100, banks can spend only Rs. 74.50 at its own will.
- Mallanna - Correct. 100 – (4 + 21.50) = 100 – 25.50 = 74.50
- Kallanna - But you were saying that banks can also borrow from RBI. What interest banks pay to RBI?
- Mallanna - Till end of last month, banks were paying 7.25% interest to RBI when it borrows money from RBI. Now this rate has been reduced by 50 basis points. So banks now need to pay interest to RBI, if it borrows from RBI, at the rate of 6.75%. This is known as Repo Rate.
- Kallanna - Can fixed deposit rate be affected by reduction of Repo Rate?
- Mallanna - Of course. If banks get money from RBI @6.75%, why will banks pay higher interest to you and me? One year FD rate is already revised by many banks and it is equal to or very close to 6.75%.
- Kallanna - But as now banks are getting money at a cheaper rate, then they should reduce the loan interest rate i.e. passing on the benefits it receives.
- Mallanna - Correct. They should. And on that hope market is cheering. If companies get loan at a cheaper rate, they will likely to expand their businesses. That will create more jobs, more income and boost the economy.
- Kallanna - How is inflation linked to this?
- Mallanna - See, when loan becomes cheaper, people tends to borrow more. That means people will have more money to spend. This will increase the demand for goods, and if supply does not increase to match this demand, then prices will increase.
- Kallanna - So there is a chance, that inflation may rise also?
- Mallanna - Well, yes. But inflation depends on many other factors as well, like production (industrial and agricultural), manufacturing, export – import, foreign currency movement etc. So inflation may increase or may not.
- Kallanna - One last question. Like we deposit our money with banks, can banks also deposit their money with someone?
- Mallanna - Yes, they can deposit with RBI and earn interest too. This interest is typically 1% less than the repo rate. This rate is known as Reverse Repo Rate.
- Kallanna - Great! So now I understand CRR, SLR, Repo Rate, Reverse Repo Rate and their impact on deposit rate, loan interest rate and on inflation. Thanks.
- Mallanna - Welcome!