Different Loan Refinancing Options and How They Can Help Meet Your Needs
Last Updated : Oct. 7, 2020, 2:47 p.m.
Refinancing means taking one loan over another, getting the interest rate changed, or paying the bulk of the principal outstanding. Like a fresh loan, it also helps individuals meet their respective financial needs. There are different loan refinancing options that you can choose to meet your needs. These options include a balance transfer, prepayment, top-up loan, loan against a credit card, etc. All these are different from each other and so are their impacts on your overall budget. Considering the same, we have decided to pay attention to each of these loan refinancing options in this post. Doing this will help you grasp these options better. So, let’s read on!
Let’s Talk About a Balance Transfer First
A balance transfer comes into play when we look to ease the effect of higher interest rates on our running loan by switching to another lender at a lower rate of interest. Not only this loan refinancing option helps reduce the Equated Monthly Installment (EMI), but also your overall interest payments.
Before approving a balance transfer deal, lender will check your credit score and your repayment track. If the score is above 700 and you have a spotless repayment track, the lender would approve this transaction easily.
It proves to be a game-changer provided you lock the balance transfer deal at the right time (when you do with a lot of repayment years left) and with the right terms and conditions.
So What are the Right Terms & Conditions for a Balance Transfer?
The definition of Right Terms & Conditions is subjective when it comes to a balance transfer. The effect of these may vary across different loans. In some, you can have massive savings compared to others where you will have negligible. The savings depend greatly on the interest rate you get on a balance transfer deal.
It has to be substantially lower in the case of short term loans like personal loans. Suppose you have taken a 5-year personal loan at an interest rate of 17% and there are about 3 years left, look for a balance transfer deal at about 11-12%. Since the new lender will most likely charge a balance transfer fee, getting the rate reduced that way will save reasonably high for you. Else the savings won’t be much on using this loan refinancing option.
Whereas, in a home loan , even if the interest rate offered on a balance transfer is around 0.50%-1% less than the current rate, it can have huge savings for you. If done in the first 2-3 years, the savings could touch around INR 3-5 lakh. The effect of the balance transfer fee may not be much here.
Let’s consider an example to understand the importance of using this loan refinancing option optimally.
Example – You have been paying a home loan of INR 45 lakh at 8.30% for the last two years. The loan will go on for another 18 years from here. Now, if you are offered a balance transfer offer at 7.65% per annum, how much can you save from the deal? On the other hand, your friend has been servicing a 5-year personal loan worth INR 6 lakh for 2 years at an interest rate of 16% per annum. Now, he gets a balance transfer offer at 10%. How much can you and your friend save from your respective balance transfer deals? Let’s check!
| Repayment Aspects | Home Loan Balance Transfer (In INR) | Personal Loan Balance Transfer (In INR) |
|---|---|---|
| EMI Payable | 38484 | 14591 |
| Interest Payable Without Balance Transfer | 47,36,232 | 2,75,450 |
| Interest Paid So Far | 7,32,212 | 1,65,199 |
| Loan Outstanding at the Time of Balance Transfer | 43,08,588 | 4,15,018 |
| EMI Payable After Balance Transfer | 36792 | 13391 |
| Interest Payable After Balance Transfer | 36,38,427 | 67075 |
| Interest Paid So Far + Interest Payable After Balance Transfer | 43,70,639 | 2,32,274 |
| Savings | 3,65,593 (47,36,232-43,70,639) | 43,176 (2,75,450-2,32,274) |
The lender could charge a fee on processing the balance transfer request, so the savings you see could reduce a bit.
How Good a Loan Refinancing Option Prepayment is for Borrowers?
Prepayment is one of the best loan refinancing options for borrowers looking to ease the debt burden. Now, it can be either a full (Payment of the entire principal outstanding) or a part prepayment (Payment of a portion of the outstanding loan balance) . The first one relieves you from the debt burden, whereas the second one reduces your payment obligations. Needless to say that both these loan refinancing options save enormously for you.
But lenders will charge on prepayment of personal loans , car loans, etc. A floating rate home loan will most likely have no charge if you are doing it from your own sources. But if you prepay using the balance transfer route, the lender can charge you. Yes, a balance transfer serves as a prepayment for your existing lender. A fixed rate home loan can have charges of around 2-4% of the outstanding loan balance or part payment amount.
How Can You Make the Most of Part Prepayment?
As said above, a full prepayment relieves you from the debt burden. Whereas, with a part prepayment, you have two options – either to go with a reduced EMI or continue with the same EMI. Either of the two will have savings for you. You could ask, what’s the point in continuing with the same EMI after doing a part prepayment? Well, it will help cut short the tenure and reduce your interest payments even more. In a home loan, you can implement this prepayment strategy better. Let’s consider the example below to understand the concept better.
Example – You are paying a 20-year home loan of INR 35 lakh at an interest rate of 8.20% for the last two years. If you go on to make a part payment of INR 10 lakh by the time the loan completes 10 years of its journey, how much will it save for you if you continue to pay the same EMI compared to when you pay a reduced EMI? Look at the table below for the same.
| Loan Aspects | When You Pay the Same EMI After Part Prepayment (In INR) | When You Pay a Reduced EMI After Part Prepayment (In INR) |
|---|---|---|
| EMI Payable on INR 35 lakh | 29713 | 29713 |
| Interest Payable Over 20 Years | 36,31,011 | 36,31,011 |
| Interest Payable Till 10 Years | 24,93,259 | 24,93,259 |
| Outstanding Loan Balance at the End of 10 Years | 24,27,753 | 24,27,753 |
| Part Payment Amount | 10,00,000 | 10,00,000 |
| Outstanding Balance After Paying the Part Payment Sum | 14,27,753 | 14,27,753 |
| EMI Payable After Part Payment | 29713 | 17474 |
| Interest Payable After Part Payment | 3,06,381 | 6,69,107 |
| Interest Payable Before Part Payment + Interest Payable After Part Payment | 27,99,640 | 31,62,366 |
| Savings | 8,31,371 (36,31,011-27,99,640) | 4,68,645 (36,31,011-31,62,366) |
The loan tenure will reduce to 59 months if you continue to pay the same EMI after paying the part payment sum. Overall, the loan will run for around 15 years, giving you more time to think about other things.
Top-up Loan – One of the Best Loan Refinancing Options
You can also get this loan refinancing option to meet your additional funding requirements. Lenders can offer a top-up loan on an existing personal loan, home loan, car loan, etc. They seek a good credit score and good income to approve this type of loan. The working methodology of a top-up loan can differ across lenders.
Some might give you the top-up at a rate of interest levied on your running loan. In such a case, there will be a consolidated EMI (based on the outstanding balance of an existing loan and the top-up amount). The combined EMI will continue till the remaining time of the existing loan. But there are cases where a top-up works separately from a running loan. There will be separate EMIs for you to pay every month using this option. For example, ICICI Bank offers both these options on a personal loan top-up .
Will You Need to Submit Documents Since a Top-up is Given Over the Running Loan Amount?
Since you need to apply for a top-up loan, lenders will ask for documents. If you apply at the existing lender, you will need to submit your latest income documents so that the concerned bank or financial institute can gauge your ability to pay the EMI of both top-up and running loan. But top-ups are also available when you do a balance transfer to another lender. If you do that, the new lender will ask you to submit documents authenticating your identity, current residence and latest income. Below is a list of documents that you need to submit.
Identity Proof – PAN Card/Voter ID/Driving License/Passport/Aadhaar Card
Residence Proof – Voter ID/Driving License/Passport/Aadhaar Card/Utility Bill
Income Proof – Latest Salary Slips & Bank Statements (Salaried), Last 2-3 Years Income Tax Return (ITR), Profit & Loss Account Statement and Audited Balance Sheet (Self-employed)
Loan Against Credit Card
This loan refinancing option is often exercised by borrowers seeking instant funds. All they need to do is ensure a spotless credit card payment routine over the years. Lenders send you an SMS or email regarding a loan against a credit card if you are eligible for it. If you don’t get any such intimation and require instant funds, you can ask the lender for such a loan.
In case you are found eligible, you will get this loan. Now, the loan sanctioned against a credit card can be within or above the credit limit of the cashless instrument. When it is offered within the credit limit, the loan amount will be blocked against the limit. Here, the loan EMI will be part of the credit card bill that you pay every month.
When offered above the credit limit, the loan amount will not be blocked. And therefore, both the loan EMI and credit card bill will get paid separately.