Are smart home loans really smart?

 

Home loans top the secured loan segment of a bank’s retail book. To address the needs of various customers, banks usually come up with variations of home loans, such as fixed-rate loans, floating-rate loans, fixed-floating loans, etc. But did you know that there is yet another category of home loans wherein your surplus funds can be linked to the home loan to reduce the equated monthly instalment (EMI) outgo? Here is how such a loan works and what it means for you.

What’s on offer?

To avail this product, you have to link a current or a savings account to your home loan at the same bank. You can deposit any surplus funds in this linked account. Whenever you deposit a surplus amount in the account, the bank considers this amount and deducts it from the principal of your home loan while calculating the interest on the outstanding home loan.

As of now, only a few banks offer this product. These include State Bank of India, IDBI Bank Ltd, Hongkong Shanghai Banking Corp. (HSBC), Citibank and Standard Chartered Bank.

Interest rates on such “interest-saver home loans” are usually higher than that of normal loans—0.5-1.0 percentage points more. For instance, HSBC, on its website, states that interest rate on normal floating rate home loan for up to Rs.50 lakh loan amount is 10.75% per annum. However, interest rate for smart home loan for the same amount is 11.00% per annum. Similarly, IDBI Bank charges a higher interest rate on interest-saver loan. Its usual home loan interest rate is currently at 10.25%, but 10.50% for the interest-saver loans. State Bank of India, which calls this product SBI Maxgain, charges 0.25 percentage points over the applicable home loan interest rate for home loans above Rs.1 crore, the bank states on its website.

How does it work?

Let’s say you take a Rs.50 lakh home loan. Now assume you have a surplus amount of Rs.5 lakh. Instead of prepaying the excess amount, deposit that money in a savings account that is linked to your home loan account. Once you do that, the interest obligation would be calculated on the loan outstanding less Rs.5 lakh (this is Rs.45 lakh), and not on the entire loan outstanding.

Another benefit is that you can withdraw this money or a part of it whenever you want. Now if you don’t have money in your savings account, even when you deposit a recurring amount in your account, this deposit will still be subtracted from principal outstanding to calculate the EMI. However, if you don’t deposit money in your account then you will end up paying a higher EMI as the interest rate is higher than that for normal home loan.

Who should opt for it?

This product has its own pitfalls. Says Adhil Shetty, chief executive officer, Bank Bazaar, “First, keeping money in a savings or current account is not profitable. Investors would rather invest in avenues such as mutual funds, which can give better returns. Second, interest-saver loans are given at a higher rate than a normal home loan. Banks typically charge 0.5-1.0 percentage points over the normal home loan rates. Calculate the probable overall savings before going in for such loans. Such loans are good for banks, too, as the chance of a customer who has a surplus amount defaulting is much lower.”

Another way of looking at it, adds Shetty, is that your deposit is earning an interest equal to your home loan interest rate. While these loans save money, borrowers must also take a wholesome view of the cost associated with it. You should factor in all the fees and penalties while calculating benefits. For instance, some banks charge an annual fee of 1% on the outstanding loan amount for this product. This can be quite expensive.

Another hurdle is that such a loan is not offered by all banks. So, the only way to avail such loans is to go to a bank that offers it. Borrowers should also check the eligibility criteria. Says Shetty, “This scheme is useful for a borrower who has a sufficiently large balance in his account, and also for a business owner who can park excess funds in his current account. The concept, though simple, is powerful. The idea is to make use of your deposit in your current or savings account to offset a part of the principal. Once some of the principal is offset, interest obligation comes down.”

Now if you are an existing borrower and want to switch to an interest-saver home loan, first look for the switching charges, which vary bank to bank. The switching fee can range between 0.5% and 1% of the outstanding amount. If you compare the surplus amount to a fixed deposit, you will benefit only if the amount is at a certain threshold.

Says Suresh Sadagopan, a Mumbai-based financial planner, “The bank is not doing you a favour through this product. For the bank, you are like a fixed deposit customer. This product treats its customer as a fixed deposit holder. Only if you deposit money beyond a certain threshold, you will benefit.”

The other problem is the tax treatment of such loans and the involved amounts. Says Surya Bhatia, a Delhi-based financial planner, “There is a grey area when it comes to taxation. Considering that you earn an interest from the money that you deposit in the account against which the loan is offset, the amount has to be disclosed to the income tax department. There is no clarity on how it will be shown. Also, the interest-saver home loan product will be pitched to those who fall in the 30% tax bracket and if they are taxed, the product will not be worth the while.”

However, even though the interest rate is higher in this product, the fact that it reduces the tenor will lower your total loan outgo.