# Should you refinance your home loan?

Refinancing a home loan is taking a new loan to pay out your current mortgage. There are many common reasons why homeowners should refinance:

1. Lower interest rate (most popular)
2. Option of lowering tenure if one has monthly surplus
3. Increase the loan tenure to reduce EMI payments
4. Shift from floating rate to fixed rate, or vice-versa

Case in point: Mr. Sharma has a Rs 40 lakh home loan at 11.25 per cent interest rate and he has made payments for the last 3 years for a 15-year tenure. Should he think about refinancing his home loan?

• His current EMI = Rs 46,094
• Outstanding principal = Rs 36,34,030
• Outstanding interest payment = Rs 30,37,655

Option 1: Refinancing after three years
If Mr. Sharma refinances his loan at 10.50 per cent interest rate for the remaining 12 years:

• New EMI = Rs 44,486
• Total interest payments = Rs 27,71,902
• Potential savings = Rs 8,62,128

Option 2: Refinancing loan after 10 years
If Mr. Sharma refinances his loan at 10.50 per cent interest rate for the remaining five years:

• EMI = Rs 45,307
• Interest Payment = Rs 6,10,515.50
• Potential savings = Rs 67,231.50

The most important question to be answered before refinancing a home loan is: When should I refinance my loan?

Now let's understand the math behind it:

EMI = [(loan amount) x (interest rate) x (1 + interest rate)N] divided by [(1 + interest rate)N - 1]

Where,

• Interest rate is equated monthly interest, i.e., if the bank offers a loan at 10.5 per cent, the interest rate to be considered is 10.5 per cent/12
• N refers to number of months, i.e., tenure of the loan.

So the factors governing the EMI payments are loan amount, interest rate of the loan and tenure of the loan. These are also the three factors which affect the refinancing decision.

1. Loan amount: EMI payments are a combination of principal repayment and interest paid on the principal amount. So while one opts for the refinancing, it is the outstanding principal that is being transferred. One has to revisit the amortization schedule of the loan to assess the outstanding loan amount and interest paid till now.
2. Interest rate: Interest rate is the governing factor in defining the EMI payments. It is important to analyze the beneficial interest rate before refinancing. Generally, it is advisable to continue with the existing loan unless there is difference of at least 0.75-1.00 per cent between the current interest rate and refinancing rate. If there is drop in interest rates is expected in near future, it is advisable to refinance your high fixed rate loans. If you expect rise in interest rates, it is advisable to go for fixed rate refinancing.
3. Loan tenure: Loan tenure is inversely proportional to the EMI payments. Higher the loan tenure, lesser the EMIs, and lesser the tenure, the higher the EMIs. Similarly, the total interest paid is directly proportional to the tenure. The higher the tenure, the higher the total interest paid. So if one has an increase in salary, but does not have a substantial amount to go for prepayment, refinancing the home loan at lesser tenure is advisable.

Always remember that refinancing your home loan comes at a charge, which differs from bank to bank. Make sure that the profit you make by opting for refinancing is higher compared to the fee and charges you pay. In most of the cases, it is profitable.

Nitin Vyakaranam is the founder and chief executive officer, ArthaYantra, an integrated online personal finance company.

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