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Refinance home loan

By Santosh Mishra  |  0 comments   |  2283 views  |   Jun 01 2012

Reasons for refinancing

  • Interest saving: Refinancing is most often motivated by lower interest rates, which has the advantage of lower EMI. We want you to understand that if you keep loan term fixed (same as the old home loan), your EMI will reduce but you will end up paying a higher interest cost over the life of the loan (see below for more).
  • Payment reduction: As indicated above, lower interest rate will lead to lower EMI. The critical choice is regarding the term of the loan. Assume that you have a Rs. 20 Lakh loan with 15 year term, and you have already paid half of it and the remaining term is 10 years. Further assume that you refinance to a fixed rate loan with 10% interest. If you revise your home loan term to full 15 years, the monthly EMI will be lower at Rs. 10.7 thousand but your total interest burden will be high atRs. 9.3 Lakh (almost twice that of the principal amount) . However if you keep the loan term at 10 years, EMI will be higher at Rs. 13.2 thousand but your total interest burden will be only Rs. 5.8 Lakh .
  • Moving between fixed rate and variable rate: Fixed rate loans tend to have higher interest rate compared to variable rate loans. Moreover, in a falling rate environment the fixed rate loan appears more expensive. In this situation, often a typical borrower tries to switch to variable rate loan to save on interest cost. If you do so, our advice is to be extra-cautious about these products. In variable rate loans you may start with a low rate which may reset to a higher rate after some time. Note that while lenders will emphasize the short run EMI benefit, they will be more reticent about long term financial burden on you. We will also like to point out that fixed rate loans are more transparent and you have complete knowledge of your EMI over the life of the loan. So if you do decide to go for variable rate product, don?t be swayed by the short term EMI saving but analyze the long run EMI changes and interest cost.
    There are good reasons to move from variable rate to fixed rate home loan. If you expect the interest rate to increase then it is useful to lock in the rate today. You are also immune to future interest rate volatility.
  • Quick payoff: This is often a great goal if you can afford somewhat higher payments. Replace a 15-year-term with 10 years, and obviously you'll be out of debt sooner.
  • Moving/changing home: We typically change home or move in certain intervals. The move may be job related or it may be about upgrading to a better place. In this situation we typically move out of our current place and move into another. In either case, it is an opportunity to revisit the current home loan and see if there is any additional benefit to be obtained from refinancing.

Type of Refinancing :

  • Term refinance: As the name suggests, here the borrower reduces/increases the term of the loan without changing anything else. Increase (decrease) in loan term leads to lower (higher) EMI and higher (lower) interest burden. We suggest you to exercise caution and take all facts into consideration. If possible always reduce your loan term to save on interest cost. 
  • Rate refinance: In case of rate refinance, the focus is on changing the interest rate. If a borrower is stuck with a high fixed rate and expects interest rate to go down the first impulse is to do either a fixed rate refinance or move to a lower variable rate product. In either case your monthly EMI will go down, but the short run benefit will be higher if you move to a variable rate loan. However, compare pros and cons of moving to fixed rate or variable rate mortgage.
  • Term and Rate refinance: This is a combination of pure rate and term refinance. In this case the borrower has the flexibility to choose both. Our advice is not to focus on the current EMI reduction and take other factors like rate reset future interest burden into consideration.
  • Cash out refinance: If you have a low remaining mortgage balance and the house value is significantly higher than the loan amount, you have the opportunity to get cash out by refinance (thus the name). Under this scheme you draw equity from the current home for present spending and pay it back to the lender over time.In a rapidly rising housing market this appears to be an attractive option. If you have other high interest bearing debt then it is a good debt consolidation option. However, we advice against taking this option to finance big ticket spending as it is tantamount to debt financed consumption. You will also take longer to retire the mortgage loan.

Understand other fees: Interest cost is only part of the story (even if a big part). Remember that you'll have to pay about 0.5 to 2% percent of the loan amount (with a floor of Rs. 5000) in additional administrative fee. This gets added to your loan amount and apart from paying this additional fee you will also pay interest on it over the life of the loan.

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