In refinancing, the outstanding loan with the existing lender is settled by the new lender who then takes over the remaining loan.
Home loan refinancing, popularly known as balance transfer, is the method of transferring the outstanding loan to a new lender. Transferring your loan to a different bank or housing finance company is helpful only when the other lender is offering a lower rate of interest. In refinancing, the outstanding loan with the existing lender is settled by the new lender who then takes over the remaining loan. Once the loan is refinanced, the previous loan account is closed.
First and foremost, the interest rates are compared and if the borrower is convinced that he is getting a better deal with a new lender he decides to refinance his existing home loan. A new lender will perform its own due diligence on the eligibility and interest rates based on the credit score of the borrower and then takes a call on refinancing. After the documentation and other formalities are completed, the loan gets transferred to a new lender at a new interest rate.
Refinancing can significantly bring down the total interest payable on a home loan. For example, Mr. R Kumar had availed a home loan with an outstanding loan amount of Rs 1 crore from XYZ bank, the applicable interest rate being 7.1% pa for the remaining loan tenure of 20 years. At the same time, several banks in the market were ready to offer him a home loan transfer at an interest of only 6.4% pa. So, there was a difference of .7% pa resulting in a saving of approx. Rs 10 lakh in 20 years if he transfers his loan to a new bank.
So, refinancing helps in such a situation when the borrower is paying a higher interest rate on the existing loan.
Why Should You Go For Refinancing?
It makes sense to refinance if you are paying a high rate of interest on your existing loan while you are eligible to borrow at a lower rate from other lenders. Typically, borrowers compare prevailing interest rates but the change in market scenario and revision of interest rates over the years make old loans expensive. Currently, borrowers are moving their old home loans to the new interest rate regime where the rates are at a historical low.
At times, a borrower feels the pinch of high EMIs. In such a situation, the borrower may get a home loan refinanced through another lender which offers a longer repayment period resulting in a lower EMI obligation. The borrower may also think about a home loan refinancing when he is not satisfied with the services or the applicable terms and conditions.
When Should You Choose A Home Loan Balance Transfer?
It is advisable to go for home loan refinancing during the early years of your loan. It can help you save a lot of interest amount. Suppose your financial position has improved and your credit score has gone up significantly, but your existing lender is not ready to further reduce your home loan interest rate, you may explore loan refinancing options to other banks or financial institutions which can help you lower the interest on your current home loan.
Also, when you need more funds to renovate your house or any other requirements, you can avail additional funds at the time of refinancing.
In the above illustration, the borrower can save approx. Rs 4.71 lakh by opting for refinancing. It’s usually beneficial to go ahead with a home loan refinancing when the total interest saved is greater than the total charges (processing charge, MOD charge, documentation fee, etc.) applicable on the loan refinancing.
Things To Keep In Mind
Factor in the interest rate and the difference it makes to your EMIs and tenure. Refinancing may incur additional costs such as processing and legal fees. Also, check for all types of other charges such as foreclosure charges (usually not applicable on floating rate loans but most banks levy it when foreclosing a fixed-rate loan), documentation charges, MOD (Memorandum of deposit of Title Deed) charge, etc. So, it is a good idea to do a thorough cost-benefit analysis.
Another crucial thing to check is the terms and conditions. Read them carefully and make sure you are not incurring any additional liability while refinancing your home loan. Focus on the long-term benefits and downsides while planning to refinance your home loan and judicially take a call considering all pros and cons.
(The author is CEO, Bankbazaar.com)