Refinancing your home loan – The Pros and Cons

Everyone has a clear understanding of what a home loan is, though the nuances and details must be researched before availing the same. However, when it comes to the concept of refinancing a home loan, many are still in the dark. In India, it is a general belief that a loan is a burden and it should be cleared off as soon as possible. While in some cases it makes sense, more often than not a loan can be a powerful financial tool if used with caution and understanding. Refinancing home mortgage can be one such essential trick up the sleeve of a savvy investor or anyone else for that matter.

Refinancing a home loan means availing a new loan from another lender to pay off an existing loan. Refinancing home loans is finally becoming an acknowledged way of reimbursing the previous liabilities and forming new ones. There are many common reasons why homeowners can choose to refinance, some of which is mentioned below:

  1. To get benefit of a lower rate of interest

This is the most common reason for shifting the home loan to a new lender. If an individual is paying a higher rate of interest and as a result, higher EMI, to lender A, he would be interested to go for a new lender if he is being offered a lower rate of interest and EMI. The new loan obtained for the reimbursement of the previous loan is usually at nominal interest rates in order to make the process of reimbursing interest every month easier and money saving.

  1. To avail a top-up on the original loan amount

Along with additional home loan refinance, customers also have the option to get additional funds by taking up incremental or top-up funding. The way they do this is by refinancing for the purpose of taking equity out of the home. A home equity line of credit is calculated as follows. First, the home is appraised. Second, the lender determines how much of a percentage of that appraisal they are willing to loan. Finally, the balance owed on the original mortgage is subtracted. After that money is used to pay off the original mortgage, the remaining balance is loaned to the homeowner. If the above sounds too complicated, here is a simple example to break it down.

Mr. A took a loan of 30 Lakhs for a 40-Lakh property he is buying. After paying the EMI for 7 years, his loan amount pending comes down to 20 Lakhs, where as his property value goes up to 80 Lakhs.  This means now he can get a loan of up to 64 Lakhs, or 80% of the present property value. He approaches his current lender, or a new lender if they are offering a lower interest rate. The lender will first pay off the existing remaining loan amount of 20 Lakhs and transfer the remaining fund of up to 44 lakhs to Mr. A.

  1. Option of lowering tenure if one has monthly surplus

Let’s again take a scenario. Mr. A, when taking the original loan, used to earn 50,000 per month and could pay 20,000 as EMI. Hence he took a loan for 30 years so that the EMI is less. After 5 years, he now earns 1 Lakh per month and can easily afford 40,000 as EMI. So he chooses to refinance his existing loan with a new loan. He chooses a loan for 15 years tenure with 40,000 EMI and closes off his previous loan.

  1. Increase the loan tenure to reduce EMI payments

Some customers also choose to do the opposite of the previous point. In case of any unforeseen economic circumstances, sometimes they refinance their existing shorter duration, higher EMI loans with longer period, lower EMI loans.

  1. Shifting from floating rate to fixed rate, or vice-versa

Home Loan customers may be facing any of the two scenarios. They may be paying a higher floating rate of interest and in such case, might be interested in moving to a fixed rate home loan, which will make their EMI constant for a certain period. On the other hand, a customer paying a higher rate of interest on a fixed rate home loan, would look to move to a floating rate home loan at lower interest, which will bring down their overall EMI and interest.

So as can be seen above, the 3 factors governing the benefits of refinancing are Loan amount, interest rate and loan tenure. However, as with any financial decision, ignorance is not bliss. There are risks and conditions involved in deciding the viability of refinancing your home loan. below listed are some factors which need to be checked and kept in mind before reaching a decision.

– It is advisable to switch the loan early on during the loan tenure. It is not advisable to switch after the first 5-6 years as a bulk part of the interest would already have been paid off by then.

– It is very important to have proper clarity on different fees and charges that are involved in the process of refinancing. Check with different lenders on charges like processing fee, valuation fee, etc and go with the one which gives you the lowest offer

– On the subject of charges, the pre-existing loan which the customer is looking to switch might come with the rider of pre-payment charges. Many lenders keep a certain clause that customers will have to pay a certain amount if they want to close the loan before a specific tenure. If anyone’s existing loan comes with the above clause, it is important to take the amount into consideration while calculating the pros and cons of going for refinancing

– It is important to note that refinancing is considered as a new loan and hence all the procedures and formalities need to be completed again. This includes legal verification of property and credit worthiness of the borrower.

-A No-objection certificate and statement of payment should be collected from the existing lender and also a statement stating that all relevant documents will be transferred to the new lender within a stipulated time-frame.

– It is hard to switch or get refinanced if the loan repayment track record is not good. Even if refinancing is secured, lenders generally charge a higher interest rate for customers with bad credit records.

Like any financial instrument, refinancing, if used intelligently after considering all facts and numbers, will go a long way in enhancing one’s finance and assets. As long as one researches properly and keeps up to date with the interest trends, it is pretty easy to stay in profit and avoid unforeseen shocks.

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