Thursday, February 08, 2007

Time to pay off your home loan


NEW DELHI: ICICI Bank's latest hike in home loan interest rates was probably accompanied by a round of groans from those who now face the prospect of paying even larger EMIs. With other private sector banks set to follow suit, is there any way they can avoid having to shell out ever increasing amounts? And what about those who haven't yet bought a house, but were planning to do so?

If you were one of those planning to buy a house, you might be better off postponing the move. According to a consultant, prices are likely to come down. If interest rates go up further, the fall will even be steeper. At the same time, rents are still low. For example, the rental of a house worth about Rs 60 lakh is just Rs 10,000 per month in Delhi. If you buy the house, your EMI would be Rs 61,920. So it makes sense to pay rent and wait.

What if you already have a house loan?

Try to reduce your liability by repaying a part of the loan from your bank deposits. On a Rs 60 lakh loan, because of the tax incentive, the effective rate of interest comes down from 11% to around 10%. But your fixed deposits with the bank earn only around 9%. If you repay a part of your floating rate loan from your own deposits, banks do not levy prepayment charge.

Should you withdraw money from PF to prepay your house loan?

Not really. Your provident fund still earns an effective post-tax return of over 11%. As we've just established, the tax sops on home loans effectively bring down the rate of interest from 11% to 10%. So you're still better off keeping money in PF. But yes, if the interest rate on home loans is hiked to, say, 12%, then it's better to pay it off even if you have to draw down your PF to do so.

Should you switch from a floating rate to a fixed rate loan?

No, say bankers and consultants. This would invoke a 'switch charge' of around 1.5% to 2% of your outstanding amount. Besides, the fixed rate is always 1 to 1.5 percentage points higher than the prevailing floating rate. While the floating rate is now 11%, the fixed rate is 12.5%. If you switch now, in the first year your effective rate would be 14-14.5%, including the switch charge. After that, it would be around 12.5%. At the same time, if in future interest rates come down, you would be stuck with the higher fixed rate.

Bankers feel a fall in rates in the medium term, say six months, is likely. They argue that if inflation is controlled, rates should fall. Also, if present interest rates continue, the economy is likely to slow down, which in turn would result in a fall in interest rates.

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