Best time to prepay your home loan as SBI, ICICI and others remove prepayment charges

Teaser rates are passe. It's the turn of prepayment penalty to take the centre stage. Though prompted by regulatory persuasion and directives, some leading banks are using the abolition of prepayment charges to entice home loan borrowers.

Last week, State Bank of India waived off prepayment charges for all customers - new or old, fixed or floating - and irrespective of whether they are paying from their pockets or switching to another lender. Almost immediately, ICICI Bank, too, removed prepayment charges for floating rate loans.

With two major banks throwing their hats in the ring, it is very likely that more banks will join the bandwagon - either bowing to the regulatory pressure or to stay competitive. At present, banks and HFCs charge a prepayment penalty of anywhere between 0.5% and 2%.

Earlier, the National Housing Bank, taking a cue from Banking Ombudsmen's recommendations, had barred housing finance companies from charging a pre-payment penalty to floating rate borrowers, even in case of loan transfers to other lending institutions. Even the Reserve Bank of India (RBI) has expressed its intention to implement the recommendations.

The logic for doing away with the penalty is simple. Since the borrower bears the burden of risk in interest rate movements in case of a floating rate loan, there is no reason why the bank should charge a pre-payment fee. For long, borrowers have complained that banks are slow in passing on the benefits of softening interest rates to existing borrowers, while luring new borrowers with much lower rates at the same time.

Despite the discriminatory practice, old borrowers were hesitant to transfer their loans to other institutions for fear of shelling out a huge amount as pre-payment charge. Until now, banks and HFCs have extended the concession only to borrowers who prepay from their own pockets. Borrowers with little funds of their own are, thus, forced to stick with their bank despite other lenders promising lower interest rates.

Now that pre-payment penalty seems set to become largely extinct, many could be tempted to exercise this option of switching to a cheaper lender. However, there are certain factors you need to keep in mind before deciding on prepaying/switching your loan.

GET THE TIMING RIGHT

With the barrier for making the switch to another lender having been nearly eliminated, the most pertinent question perhaps in the current context is when to prepay the home loan. For loans being prepaid with own funds, most banks and HFCs already follow the practice of waiving the penalty for fixed as well as floating rate loan borrowers.

Things have never been better for those looking to pre-pay, particularly, if you have just started repaying your home loan. "It is advisable to repay as much as possible during the first five years. For, the interest component in your EMIs is huge in the initial years, while the principal element is miniscule," reasons Vipul Patel, director, Home Loan Advisors, an independent mortgage consultancy firm.

Thus, you will be saving on considerable interest outgo if you can focus on directing your savings towards prepaying a significant part of the loan during the first five years.