The Reserve Bank of India (RBI) lowered the repo rate, in March 2020 it was cut down by 100 basis points this year. This effects loan interest rates directly. Banks immediately have reduced their home loan and personal loan rates. Some banks are providing home loans at as low as 7.45% per annum.

The news is good for borrowers who have floating interest rate loans but banks may be slow to pass on the benefit or only partially pass on the benefit. So what should a borrower do when loan rates drop?

You have three smart options — refinance your loan, prepay the loan if you have funds available, upgrade your house.

1. Refinance to reduce EMI or tenure
Refinancing means simply switching an existing loan to another lender who offers the same loan for you at a lower interest rate. This will also reduce the total interest cost of your loan, an example; suppose you borrow ₹50 lakh at… show full content

According to Pramod Kathuria, CEO of the Lodha Group’s Easiloan. If you refinanced at ₹9% to ₹8% your interest cost over the remaining term, you could likely save over ₹4.5 lakh. You will usually have to bear some processing fees, therefore your net savings is slightly lower.

Refinancing using the same EMI will help reduce your tenure. You may also save almost 2 years of your tenure payment if you go down this refinancing path.

Refinancing is the most powerful when your loan has a long remaining tenure. Ensure you check the processing and other legal charges if you choose to switch from your current loan provider.

2. Make Prepayments for Interest Savings
If you have spare cash, prepaying your loan is a good thing you can do. Prepaying will reduce your interest outgo and your tenure. Example, on a ₹50 lakh loan (20 years @9% p.a.) Prepay ₹5 lakh in Year 1 and your remaining principal will reduce by roughly ₹8 lakh.

Interest is higher in your early EMI years so prepaying in Year 1 saves the most interest compared to prepaying in Year 10. There are no prepayments penalties on floating loans. You can also increase your monthly EMI slightly each year. This method would save interest and by doing it, effectively lower your loan duration.

3. Buy Bigger If You Can Afford
Lower interest rates also make borrowing cheaper. If you are considering upgrading into a bigger house, this is also a home-buying opportunity. Cheaper loans means your monthly EMI is also lower to achieve a higher loan amount. But do put no faith in short-term gains alone.

Always consider your long-term income, job security and future expenses before you increase the size of your loan. A larger home will also likely incur higher home maintenance.

Be sure you are comfortable making higher EMIs for the next 10–20 years.

Choose What is Right for You
There is no right or wrong answer. You should decide based on your loan size, your finances goals and your disposable monthly income.

Do you want to save money? Refinance or prepay.

Do you want additional space? Upgrading – only if you can afford it.

Not sure? Speak to a financial advisor.

Also Read: 5 Powerful Tax Benefits On Home Loan: Just Do This While Filing ITR

The right decision today can save you lakhs of rupees in the future.

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