Remortgaging: Moving to another home loan plan-2: Finance Trading Times

Remortgaging: Moving to another home loan plan-2

This is part II of the article Remortgaging: Moving to another home loan plan. Please read the first part before proceeding with this one

In case of home loan fixed or floating, the banks have to deal with this interest rate variation for a much longer duration – 15, 20 25 years. This becomes a major risk for them as the amount of money at stake is also high. Therefore, when one takes a floating home loan from a bank, initially he is shown the juicy carrot of 0.5% lower interest rates than fixed and then he is ripped off his money by increasing the floating rates as soon as RBI changes rates but not reducing it when the RBI cuts the rates.

This way or that way, fixed or floating, the banks win at all fronts. The financial planning of the individuals may or may not fail – because he becomes the victim of rates variations – a victim of randomness.

But do banks simply keep on charging anything they like in the name of floating rate? No, they don’t, because the market is efficient. Suppose that you started repaying a floating home loan with 10% interest rate. But after 2 years, the bank gradually increased it to 14% owing to the market changes. However, it is offering a discount to the new customers, who are offered loans at 13.5%. What do you do?

The fact is that banks cannot simply keep on raising the interest rates as they wish. Because there is competition from other banks in the market and if rates are increased to a high level, then the customer may go for what is called Remortgaging - meaning, financing the present loan which is costing him 14%, with another bank which is offering say 13% to new customers. Hence, if you took a loan of 3 million and have an outstanding of 2.5 million, then you can save 1% by remortgaging, i.e. 1% of 25 lakhs = 25K each year. The compounded value of this 25K will be much higher.

Banks know this fact very well, hence they do not increase the floating rates randomly as per their will and wish. However, they still have a mechanism to extract money from you. If you remortgage, there are pre-payment charges typically 2%. Hence, If you are remortgaging to save the 1% (or 25K each year), then upfront you will have to pay 2% to your existing bank which will be 2% of 25 Lakhs = 50 K. Then there will be other formalities like stamp duty on new agreement, insurance of home to new bank as beneficiary (or transfer of benefit), your personal insurance, etc., etc. Ultimately, it all becomes almost null and void.

If you are getting fed up of your present bank which was good to you in the beginning and now charging you higher interest rates for EMIs, what is the guarantee that the new bank will not do the same to you after sometime?

Hence, think 10 times before selecting a plan or a loan. Be it a small personal loan or two-wheeler loan or a big long term commitment like housing loan. It is not at all advisable to be in debt irrespective of whether the interest rates are high or low – unless and until you are using the loan money for further profits. Don’t forget that this is India, where the bureaucratic system is hopeless. A complain in the consumer court takes years to resolve. House is a necessity, one needs it. But don’t base your judgement on faulty assumptions of your salary – its eternal growth and its eternal continuity.

I will agree with only 1 point mentioned in the book Billionaire in Training by Bradley J Sugars, however

A paycheck, no matter how big, cannot be defined as wealth or riches. So often people seem to mistake getting a bigger paycheck or salary for getting richer.

The biggest thing with a paycheck is that it might stop anytime, you never know, as this cute little puppy discovered after the big deal :-)

Link to previous article : Home loans: Fixed or Floating Interest Rates?

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4 Comments: Post your Comments

nickp2 said...(on 26 November 2007 at 19:54 )  

Hi Shobit,

I have a small hypothetical question for you.
Lets assume that we have a sum of rupees 10 lakh.There are no obligations like home loan or any personal loans.What would be the best way in which we can invest this money in order to get decent returns.Consider that the person has a average risk taking probability.We can also assume that the person does not want to buy a house of his own as of now.

Investment n Trading Advisor said...(on 27 November 2007 at 19:54 )  

Nick,

It depends upon your investment horizon and your needs.

If you want to get a regular monthly return - go for monthly income Fixed deposit in a bank. If you have more than 3 years of investment horizon and you do not want regular income and avoid risk, then lock in the money in tax-saving bonds or infrastructure bonds or high interest bank FD (like offering 9.5%). This is for low risk apetite.
For average risk apetite:
TO me, the best way to play around with this 10 million is to put the money in bank FD and get a monthly return. Using this monthly return, keep on investing in any index based ETF on monthly basis like a SIP. In the long run, you will keep on getting interest from FD and your index based ETF will also grow. Just for an example, putting 10 lkahs in an regular income monthly FD with 8% will generate around 6500 per month. Use this money to keep on buying Nifty based ETF each month. Your principal of 10 lakhs will remain secure with FD and your ETF portfolio will build up.

Hope this answers your question

Rshri said...(on 30 November 2007 at 17:20 )  

Hi Shobit,

Let me ask you something in the same context - Do you personally think that making big long-term fixed deposits in a private bank is a good idea? (E.g. ICICI, HDFC etc) Shouldn't we be making very big fixed deposit in a ntionalized bank only to be on safe side?

Investment n Trading Advisor said...(on 2 December 2007 at 21:58 )  

As far as my knowledge goes, even the nationalized bank deposits are secure only to a TOTAL AMOUNT OF 1 Lakh.
THat means, say if you have 3 accounts at a nationalized bank, all in your name, and you have a TOTAL of 1 lakh 10 thousand Rs. spread across all the 3 accounts. The government (Through RBI), which controls the nationalized ban, guarantees ONLY 1 LAKH Rs. MAXIMUM security if the nationalized bank goes burst. Hence, even in nationalized banks, your security is limited to 1 lakh.

I dont know certainly about private banks, but I understand that same clause may apply to them as well.

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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