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Home loan spread & how it can lower your EMI

Having a house of one’s own is something many of us aspire to. The BankBazaar Aspiration Index survey, the largest study of India’s aspirations through the lens of personal finance, also affirms the sentiment that homeownership is, indeed, a top priority among Indians. Home loans allow you to spread the cost of buying a house over several years, thus making the purchase feasible.

Currently, as home loan rates continue to spike, borrowers need to understand all aspects of the home loan process to lower their EMI burden. In this article, we will discuss what a home loan spread is, and how it can affect your debt burden.

What is a home loan spread?

The benchmark rate and loan spread are two important components of a retail loan. The benchmark rate is the lowest rate at which a loan is given whereas the loan spread is computed based on parameters such as the borrower’s credit score, source of income, and the size of the loan. The spread varies for different borrowers and is calculated based on their credit score, source of income, and their loan quantum. Following RBI’s directive in 2019, most banks now benchmark their home loan rates to the repo rate, which currently stands at 6.50.

Why is the spread important?

Floating interest rates on home loans are set based on lenders’ policies, inflation rates and repo rate changes. A rise in the repo rate will likely cause home loan EMIs to go up. But owing to the dipping spread rate, banks are not hiking loan rates in line with the rising repo rate. The spread at which a loan is availed remains constant during the loan’s tenure. In March 2020, the spread rate was nearly 3.50, but as of March 2023, it has fallen to 1.95.

Understanding the difference between the prevalent home loan rate and the spread rate can help borrowers save money. This difference has fallen steadily from 2.65 in March 2021 to 1.90 in March 2023. If the repo rate starts to fall, you will benefit from the constant lower spread rate. Let’s understand how this is significant with an example.

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You have taken a loan at the lowest spread rate of 1.90. Now, if the repo rate starts falling and stops at its lowest, of 4%, your interest rate will only be 5.90. Compare this with someone who has also taken a home loan at a spread rate of 2.65%. Their approximate interest rate will be 6.65%. Thus, a lower spread can help you rake in significant savings on your home loan EMIs.

Who gets the lowest spread rate?

Borrowers with a high credit score and stable income are most likely to get the lowest spread rate, which remains constant throughout their loan tenure. So, while the rate may fluctuate, the spread rate remains unchanged. The current low spread rate is favourable for new borrowers who can start their loan at a lower rate compared to pre-pandemic borrowers who may be paying a higher amount over the market rates. In this situation, existing borrowers may consider refinancing their loan to a lower spread.

Different ways to reduce your loan burden

Refinance with your existing lender: Request your existing lender to refinance your loan to the lowest rate they have to offer. Do check the processing fee applicable in this case, as it may affect your final refinancing cost.

Refinance or balance transfer to another lender: Refinancing with another lender is another option to save on interest which may involve paperwork. Before going ahead, check the additional costs which may be involved, such as the processing fee, legal fee, and MOD charges.

Increase your EMI: If you wish to lower your debt burden faster, consider upping your EMI amount. Assess your finances before taking this step as the increased EMI may stress your budget.

Pay one extra EMI every year: If your finances permit, try pre-paying an extra EMI at the start of each year. This will help lower your loan tenure in the face of increasing rates.

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Pre-pay 5% of loan balance yearly: If your income has increased over time, consider pre-paying 5% of your outstanding loan once a year. This strategy can help you reduce your loan burden faster.

Pre-close if the rate is too high: If you have sufficient savings, using which will not affect other financial goals, consider fully pre-paying your outstanding loan. While it is a drastic move that must be decided carefully, it can help you be financially stress-free.

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Home loan rates are expected to continue rising in the first half of 2023. Making only EMI payments may no longer be enough. The strategies mentioned above may help borrowers save on their loan payments.

Adhil Shetty is CEO of BankBazaar.com

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