How a government bank can do like this?
This was the comment by Gokul, when I discussed about his home loan. He is a home loan customer of a PSU bank which offered 8.25% fixed interest for the first 3 years. The loan was 25 lakhs for 20 years with an EMI of Rs.21, 302/-. He took the loan in 2009 and paid 36 EMIs. He paid 7.67 lakhs totally so far in these 3 years.
After taking this home loan, he has taken some personal loan to furnish his house, for which he is still paying the EMI. His 2 children are still in school and EMI s and school fees took a larger chunk of his net salary.
Now, he got a letter from the bank stating that his EMI will increase to Rs.24, 191/- for the next 17 years. This is because the rate of interest is revised to 10.25% now. This monthly increase of around 2889/- is big for Mr. Gokul to manage.
Out of the 7.67 Lakhs repaid by Gokul, only 1.67 Lakhs was adjusted against the principal and around 6 Lakhs was adjusted against the interest in the first 3 years of the loan. This is the situation in all such loans where the majority of EMI goes towards adjusting interest. It is better to pre close the loan in the initial years, so that the principal will come down and the loan can be closed earlier.
Now look at the other option. If Gokul cannot pay the higher EMI, the other option is to increase the term of the loan keeping the same EMI. In this case, he has to continue the EMI for another 322 months as against the original 240. An increase of almost 10 years! He will be repaying more than 76 Lakhs for this loan of 25 Lakhs.
This is the situation for many teaser loan customers who took the most popular loans at that time. Those who stretched themselves to the full loan eligibility are suffering now. The loan business was booming, when most of the banks were offering such attractive rates.
Go for loan as per repayment capacity, not as per eligibility
It is always better to go for a home loan within the means, even if you are eligible for more loans. Home purchase is only one of the major financial goals in life. You cannot postpone your children education and marriage for this. More important is the provision for your retirement.
Will you preclose the home loan?
It makes sense to preclose the home loan in the initial years of the loan, when the outstanding loan is high. You have to balance the situation taking into account your monthly surplus, interest rate situation, income tax benefits etc. In most cases, it will be better to preclose the loan, especially in higher interest rates regimes like this. Though the interest rates may cool a bit this year, it may not come down so fast.
Gokul is now planning for a PF loan to preclose his home loan and get out of the trap.
hi
finwin i think a better option for common man for his financial planning
ajith
I fully agree with the plight of people like Mr. Gokul. The idea is to enlighten other readers about the nature of teaser loans & how to get around it without getting hurt.
First & foremost as you said: buy a house within permissible budget & borrow as little as possible without looking at eligibility norms as to how much maximum loan you can get.
Secondly, the lender i.e. the banker may compel you to sign on the dotted line, but a wise borrower shall always opt for a fixed rate of interest after the initial period of juicy 8.25% interest rate expires. Should never opt for floating rate after the completion of first year. This is the biggest worry some factor in future, which is like guessing the interest rate movements in future.
In 2008 at the height of U.S. sub prime crisis, home loan rates (floating) sky rocketed to around 15-16%.
Therefore it is wise to opt for fixed rate loan at the time of disbursement itself & delete the clause of floating rate interest from second year onwards.
The fixed rate of interest on home loans from second year onwards are around 10 to 10.5% which are reasonable enough to pay in the long run. Floating rates are suicidal, they may climb back to the 2008 levels making borrowers jittery.
I for one, opted for a fixed rate of interest from second year onwards, after expiry of first year 8.5% teaser rate. This was done forcefully by myself by deleting the floating rate clause from the loan agreement, much to the chagrin of the lender.