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Tuesday, February 26, 2013

What is a Home Saver Loan

Home Loans or Mortgage is one set of financial transactions that almost everyone of us is bound to encounter at least once during our life time, and then deal with it for a majority of our life. So, any available option in this area should be explored very carefully.

Most of us, after a few years of running a successful EMI schedule would also look at the option of pre-payment of home loans. 
Pre-payment of home loan is a double-edged sword. It reduces the future obligation but at the same time, also incurs opportunity cost and risk in case of an emergency when you urgently need cash. This is exactly where a home saver loan helps.

What is a Home Saver Loan?
Home Saver Loan is a kind of loan where you have a dual advantage of pre-paying your home loan (and thus reducing your balance amount or tenure or both of EMIs) as well as having ready cash in hand which can be withdrawn in case of an emergency.

How does a Home Saver Loan work?
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.

Here is how it works:
1) In this type of home loan, the lending bank links your home loan account (an account which you would already be running with the bank from which you have taken the home loan) with a current or savings account with the same bank.
2) While calculating the monthly interest on your home loan, the bank deducts the funds in the current account from the principal outstanding and then levies the interest, resulting in reduction of your EMI

This scheme is quite useful for a borrower who has a sufficiently large savings balance in his account, which he wishes to utilize when in need, and also for a business owner who can park excess funds in his current account.

For example, you think of making a prepayment of Rs 5 lacs. Instead of pre-paying, you can deposit that amount in a savings account which is linked to your home saver account.
Then, the interest obligation would be calculated on the loan outstanding less Rs 5 lacs, and not on the entire loan outstanding. The biggest lever is that you can withdraw this money or a part of it whenever you want.

Such savings can be quite huge when you consider the fact that EMIs will have to be paid for several years more.

What if you do not have immediate funds?
In that case, even when you deposit a recurring amount in your account, this deposit will still be subtracted from principal outstanding to calculate the EMI.
The savings would be less in initial months but will compound in the later part of the tenure.

While certainly an innovative product, it has its own pitfalls.
1) Keeping money in saving or current account is not profitable. Investors would rather invest in avenues such as mutual funds which can give better returns. 
2) Home saver loans are given at a higher rate than a normal home loan. Banks typically charge anywhere between 0.5 and 1 per cent over the normal home loan rates. For example, for a loan amount up to Rs 25 Lacs, IDBI charges 10.5 per cent floating rate of interest on a normal home loan. The same is 11.5 per cent on home saver home loan. 
3) Moreover, home saver loans are currently not offered by all banks. A few banks that do are Citibank, Standard Chartered, IDBI, HSBC, ICICI, and SBI. 

What should you do?
I always advise my readers to do a simple RoI (Returns on investment) calculation before taking any financial decision:
1) Calculate the probable overall savings before going in for such loans. It is not difficult to calculate. 
What you save : You save roughly 12% (rate at which your home loan runs today) on the parked amount.
What you lose : Your money is blocked in a current account not earning anything. If it was in a regular savings account, it would have earned 4% approx interest. If you would have invested it in mutual funds or equity market, then may be 10-12% is what you are losing. So, decide what you are losing depending upon what you can do with that money if you do not block it in a home saver account.
What else you gain : Liquidity with the money.

2) Borrowers should also check eligibility as criteria for home saver loans vary.

Finally, this option is relatively better only when you have enough money to park in the linked account. Also, always take time to discuss with the bank and understand how the calculations are done to ensure you have a transparent understanding of any additional interest costs that might be incurred.

Money saved is money earned. Take smart financial decisions - they are no less than a job promotion or a business deal:)


Manoj Arora