Wednesday, May 16, 2012

Prepayment is best way to get out of home loan - Indian Real Estate Forum -

Prepayment is best way to get out of home loan - Indian Real Estate Forum -

RBI has banned banks from levying penalty on home loans

In its Monetary Policy 2012-13 this week, the Reserve Bank of India (RBI) has banned banks from levying a prepayment penalty on home loans taken on a floating interest rate. Although last year, several large banks such as State Bank of India, ICICI Bank, Bank of Baroda had already waived off prepayment penalty charges for home loans taken on a floating rate, the regulation now ensures that all banks have to follow it mandatorily.

“Though many banks have, in the recent past, voluntarily abolished prepayment penalties on their floating rate home loans, there is a need for ensuring uniformity across the banking system in this regard. Accordingly, it is proposed not to permit banks to levy foreclosure charge-s/prepayment penalties on home loans on a floating interest rate basis,” added the RBI policy statement.

More than 95 per cent of borrowers have taken home loans on a floating rate basis. Banks till now were charging 0.5-2.5 per cent of the outstanding loan as prepayment charges.

Should you prepay your loan? Prepaying a loan is the best option to get out of your home loan fast. Saving on net interest is a significant advantage of prepaying a home loan, other than the fact that you will retain the complete ownership of the house earlier than planned.

Consider tax benefits before prepaying: Says Jaideep Lunial, a certified financial planner, “You should take into account the impact of prepayment on the tax benefits you can avail.”

Under Section 80C of the Income Tax Act, a borrower can get a tax deduction of Rs 1,00,000 every year for repayment of principal. He can also claim deduction of up to Rs 1,50,000 per annum under Section 24(b) for the interest paid on the home loan.

“Do a cost-benefit analysis taking into account the tax deductions before prepaying. For those who are in the 30 per cent tax bracket, they should prepay only if the interest outgo is above Rs 1,50,000 per year (under Section 24),” says Lunial.

So should you prepay your loan or switch to another bank? The irony today is: If you are approaching the banks for a home loan as a new borrower, your interest rate will be lower than those who already have taken a loan out. While existing home loan borrowers were seeing their equated monthly instalment rise with rising interest rates, new borrowers get home loans at a lower interest rate. The average rate of interest charged to existing customers is between 11-11.5 per cent, while new home loan borrowers are entering at an interest rate of 10.5-10.75 per cent.

According to RBI, the removal of the prepayment penalty on home loans will lead to a reduction in the discrimination between existing and new borrowers.

Factors to be considered if you are switching to another bank: “You have to consider several factors if you want to switch your loan to another bank. Find out what interest rate is being offered by the new lender, what will be the processing charges of the new lender and how old your loan is and what the balance interest is that has to be paid,” Surya Bhatia, a certified financial planner says. “If your loan is old and you have paid most of the interest balance, then it does not make sense to switch to another bank.”
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