Big ticket size and longer repayment tenure, stretching up to 20-30 years, often cause home loan’s interest cost to exceed principal. In their bid to reduce the interest on home loan, borrowers often consider opting for the balance transfer or prepayment options.
However, a smart alternative for prospective home loan borrowers to reduce overall interest cost is to opt for a home loan with an overdraft facility also termed as a home loan interest saver or smart home loans. Existing borrowers may also avail of this facility by checking with their existing lender or consider transferring the loan to another lender offering the overdraft facility.
Let us take a look at the pros and cons of a home loan overdraft facility
Reduces overall interest cost
“Under the home loan overdraft facility, borrowers can deposit surplus funds in their home loan overdraft account, usually either in the form of a savings account or current account linked to the home loan. The average balance of the linked account is deducted from the outstanding loan amount while calculating the interest component,” said Ratan Chaudhary, head of home loans, Paisabazaar.com.
Moreover, the surplus fund parked in this account acts like a prepayment against the outstanding principal, thereby reducing the overall interest cost of the home loan.
Flexibility to withdraw fund as and when required
The flexibility to deposit and withdraw surplus funds from the home loan overdraft account helps home loan borrowers retain liquidity, which would be compromised if they opt for partial prepayment or foreclosure of the home loan instead.
Avoid prepayment penalty
Although prepayment of floating rate home loans does not involve prepayment/foreclosure charges according to RBI guidelines, lenders may levy such charges on fixed-rate loans. Home loan overdraft option can help avoid prepayment penalty. “The surplus funds parked in the home loan overdraft account act like a prepayment against the outstanding principal and thereby reduces the overall interest cost of the home loan,” said Chaudhary.
No tax benefit
From a tax perspective, the surplus amount deposited in the home loan account does not qualify for Section 80C of Income Tax rebate, as it is not treated as pre-payment.
Comparatively higher interest rate
The interest rate of a home loan with an overdraft facility is usually a notch higher than a regular home loan’s interest rate.
Adhil Shetty, chief executive officer, BankBazaar.com said, “Home loan overdrafts usually tend to be more expansive, and they can be a good move only if you have surplus funds available with you. If you do not have a chance to generate a regular surplus amount, the home loan overdrafts may not be the right choice as you would be paying more for a benefit you cannot utilize.”
“There’s also the opportunity cost involved with overdraft loans. With the home loan overdraft facility, you are deploying your savings towards early repayment. This may not necessarily be financially sound as your savings may have the potential to earn a higher return than the interest saved if invested wisely,” said Shetty.
Hence, opt for this facility after calculating whether the interest saved through surplus parked in a home loan overdraft account would outweigh the higher interest cost of this home loan.