Interest rate falls: Is it a good time to prepay your home loan?

After big interest rate drop should you consider prepaying your home loan?

Whether you are a floating rate or fixed rate home loan borrower, it hardly matters, as such a huge interest rate reduction gives you a unique opportunity to accelerate your home loan repayment through partial prepayment.

After the government demonetisation drive and banks being flooded with deposits, the interest rate in India in general has witnessed an unprecedented decline. Home loans being the biggest liability of life for most of the people, everyone wants to pay it off as soon as possible. In such a scenario it makes sense for you to review your home loan repayment and check whether it suits you to make some partial prepayments. 

In case you are having a floating rate home loan then the chances are that you would automatically get the advantage of interest rate reduction. To introduce any reduction in bank's lending rate the bank has to reduce either the Base Rate or MCLR (Marginal Cost of Funds based Lending Rate) a new benchmark to which loans are now linked. The moment these benchmark rates are reduced by the lender a new borrower can get loan at new reduced rate. Besides this the interest rate of eligible existing floating rate borrowers are also reduced. Some borrowers, who have taken loan after March 2016 under the new MCLR system, will have to wait at least for a year when they can contact their lender and get their floating rate adjusted. Some old borrowers who have their floating rate home loan still linked to old Base Rate system should immediately contact their lender to get the advantage of the reduced rate by shifting their loan to new MCLR system. 

After any reduction in interest rate a lender typically does not reduce your EMI but it reduces the loan tenure. A fall in the interest rate reduces the interest amount included in your EMI and since the lender wants to keep to future EMI same therefore a higher principal amount goes towards loan repayment. With more amount going towards principal repayment the overall home loan repayment gets faster and as a result the tenure of the loan get reduced. However if you find your lender preferring to go for a reduced EMI then you would need to request it not to reduce your EMI in case you wish to prepay your loan faster and willing to pay the same EMI as earlier.

In case you do not find any reduction in your interest then you should consult your lender to know the reason. One of the reasons could be your existing home loan being linked to the old base rate system. You can request the lender to shift your home loan to new reduced rate by linking it MCLR, the new bench-marking system. For doing so you may be asked by the lender to pay a nominal one time fee for switching. Once lender accepts your request you would get the advantage of the reduced interest rate. However after this reduction make sure at least not to go for EMI reduction and keep the same EMI as it would help you prepay your loan fast as explained earlier. Moreover if you wish to make prepayment over and above this, then it makes sense for you to go for partial prepayment as there is no penalty on prepayment of floating rate home loans.

On the other hand if you have fixed rate home loan then you would need to calculate your net benefit for a prepayment as you would need to prepayment penalty which could be in the tune of 2-4% of the prepayment amount. Since there has been around 2% reduction in home loan rate in last 3 years and fixed rate home loan comes with a premium therefore it is more likely you would gain from making a prepayment even after paying a penalty. 

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