Articles

Products like offset balance home loans can reduce tenure and interest outgo but returns should beat inflation and you would have to pay tax

Usually, a home loan is one of the biggest liabilities. Considering the huge amount and the long tenure involved, it is advisable to repay the loan at the earliest. And, as both the Reserve Bank of India and the National Housing Bank have abolished the penalty on prepayment of home loans (for floating rate loans), it is sensible to prepay your home loan and save on interest. For those lacking the financial discipline to save and build a corpus to prepay a loan, some banks offer a product through which one can deposit small surplus amounts into a current account.

This can be offset against the due amount on the loan; this would reduce your loan tenure, as well as the interest. You could also link the loan to your salary account and withdraw only the amount required for essential expenses. This would ensure a substantial balance in the account, which could be offset against the due amount on the loan. Consider a scenario in which one has availed of a home loan of Rs 20 lakh and is paying an equated monthly instalment (EMI) of Rs 22,000. Of this, Rs 2,000 goes towards the repayment of principal, and Rs 20,000 towards repayment of interest. If you deposit Rs 10 lakh in the account linked to the home loan, the repayment on interest falls to Rs 10,000.

As the monthly EMI remains Rs 22,000, the additional Rs 10,000 goes towards principal allocation, which could effectively reduce the interest on the entire sum, as well as the tenure of the loan. Compared to prepayment, this is advantageous. In the case of prepayment, banks might insist at least a certain amount be paid, say an EMI or three EMIs or, in some cases, a figure of Rs 1 lakh. But in the case of an offset balance home loan, there are no such requirements - you could deposit any amount in the account, says Vipul Patel of Home Loan Advisors, an independent mortgage advisory firm. A second advantage is if you decide to prepay a home loan, you would have to part with the money but for an offset balance home loan, if you deposit a certain amount in your current account, you could withdraw the money when required, says Sumeet Vaid, chief executive of Ffreedom Financial Planners.

Since the interest is calculated on a daily reducing balance, even if you withdraw money, the benefit you have received would hold. But the prospective benefit would reduce, says Patel. However, this advantage comes with a cost---banks offering this product charge interest 25-50 basis points higher than that on normal home loans. Manish Sinha, head (customer value management), HSBC India, says, "The savings on interest payments could be substantial, depending on how much money the customer chooses to deposit in his account. It also provides the borrower liquidity in managing the deposit float, as these excess funds can be utilised freely.

Finally, the customer can use this account as a regular bank account, for which a cheque book and debit card are provided for routine banking transactions. Therefore, a nominal interest rate premium is levied for this significant advantage to the customer." Many banks offer these products - HSBC offers the Smart Home, State Bank of India’s has the SBI Max Gain, while Standard Chartered Bank and Citibank offer Home Saver and Home Credit, respectively. Kiran Kumar Kavikondala, director, WealthRays Group, says since a current account has an overdraft facility, frequent withdrawals from the account could increase the tenure of the loan. Is it better to invest in other instruments and use that money to prepay a home loan? Yes, says Kavikondala.

Typically, the tenure of a home loan is about 10 years. This provides an opportunity to save in other instruments in a disciplined manner; these provide higher interest compared to home loan interest. For instance, instruments such as equities, mutual funds, exchange-traded funds, corporate fixed deposits and National Spot Exchange-agricultural commodities provide annual yields of more than 12 per cent through three to five years. But for such instruments, it is important to have a systematic approach, not lump sum investments to average the cost of investments and match inflation rates.

"This product (offset balance home loan) is suitable for borrowers who lack discipline in savings on a regular basis, or those who don’t retain savings," Kavikondala adds. If you decide to invest the money in an instrument and use this to prepay the amount later, you should ensure the post-tax returns are higher than the interest charged by the bank on the home loan. Only then is this option viable, says Vaid.