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Home loans cheaper with rate cut?

The RBI has cut repo rates by 50 basis points. A number of public and private sector banks have cut base rates. You dare to dream. Finally your dream home is in sight. But does a cut in the base rates by banks mean, the interest rates on your home loan is coming down?

How do banks calculate the interest on your home loan?

Banks fix the interest on your home loan based on their base rate. Base rate is the minimum lending rate of the bank. Banks do not lend below the base rate.Each bank fixes its own base rate. Banks are free to decide the base rate based on their cost of funds. (The interest banks pay on the savings/current/fixed deposits invested with them).
Banks have administrative and other expenses .They also need to earn a profit on the home loan they give you. Spread takes into account the expenses and profits of the bank, when it has to lend you a home loan.
Your home loan lending rate is calculated based on:

So now the big question. Does a cut in the base rates by banks mean the interest rates on your home loan is coming down?

Many banks have cut base rates but have also increased the spread. A spread is the rate charged over and above the base rate. This means that if the bank has reduced the base rate, it will add a spread to this rate.If you are a new borrower, you could avail a home loan at an interest rate, which is much lesser than what it was last year. This should encourage you to avail a home loan. You must also note the processing fee, documentation and stamp duty fees while availing a home loan.

What if you are an existing borrower with the bank?

If you are an existing home loan borrower with the bank and the bank has cut base rates, the interest rates on your home loan will reduce. The bank will not touch the spread and it remains the same. You pay a lower rate of interest on your home loan due to the cut in base rates.If you had availed a home loan from the bank when interest rates were high, the bank would have reduced the spread .This was done to encourage you to avail a home loan, when interest rates were high.Now when base rates are cut, your spread remains the same, but you get the home loan at a lower interest rate. If a new customer avails a home loan he will get the loan at the reduced base rate (same as the existing borrower), but at a higher spread.This means some existing borrowers of home loans with banks, are charged a lower interest rate than new customers.You are an existing borrower of a home loan with a bank. The bank has reduced the base rate.
Does this mean a cut in your EMI’s?
No, the EMI you pay on your home loan remains constant. The bank however reduces the tenure of your home loan. This means your home loan gets repaid faster.

Should you switch your home loan when banks reduce the base rates?

You want to switch your home loan to a new lender. Must a lower interest rate be the only thing you consider? No, you must also take into account the remaining tenure (time period), left behind on your home loan. You must also consider the foreclosure charges of the bank where you have availed the home loan, as well as the prepayment charges of the new bank, where you plan to switch the loan. You would also have to pay charges for the bank to check your property, documentation and stamp duty fees. You have just started paying the EMI’s on your home loan and have a long tenure remaining on it. Another bank charges a much lower interest rate on their home loans. If the savings in interest, after accounting for the cost of switching the home loan is high, then you must switch your home loan. However if the end of the tenure of your home loan is fast approaching, then you must not switch your home loan. The festive season is here. Be smart and choose a bank which offers a home loan with low interest rates.

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