Sunday, September 16, 2012

Commitment Rewards

This article was originally published in Postnoon on September 14th, 2012

http://postnoon.com/2012/09/14/commitment-rewards/72810

I saw Abhi waiting for me again near my office. He had applied for a home loan about two weeks back. I had explained the process of applying for the home loan and also how the EMI's work. I wondered what's brought him back to me so soon. I didn't have to wait long. He had his papers out, even before I could open the door to my office.

Abhi: Nicky, the bank has sent people over to my house to check if I actually live there. They even called and visited my office.

Nicky: That's routine. Nothing to be worried about. They are just doing their job. Due diligence.

Abhi: Yeah, yeah. I understand. I am not here for that. Yesterday, my friend told me about a scheme that Axis Bank has come up with. He told me that if I take a loan for a period of 20 years and keep paying all my EMIs on time, without any defaults, the bank will waive off my last one year installments (that is last 12 months' installments).

Nicky: Oh yes, I heard about that. You need to be locked with them for 15 years time to avail of that offer.

Abhi: How does that matter?

Nicky: Oh it does. Because it means that you cannot avail this benefit if you decide to prepay your loan before 15 years. It also means that you cannot avail this benefit if you transfer your balance to another bank, if they offer to charge a lower rate of return.

Abhi: Does this mean that the scheme is useless?

Nicky: Not at all. I'll explain this with an example. A person taking Rs 50 lakhs as loan, for a period of 20 years, at 11%p.a. interest, will need to pay an EMI of Rs 51,609 per month. According to this scheme, he will be able to save Rs6,19,308 after 15 years, the equivalent of one year's EMI.

Abhi: That's quite a lot of money!

Nicky: Well. So it seems. But then, you see, the value of money 15 years down the line, is not the same as the value of money today. So its present value, after accounting for an average inflation of say 7%, is just Rs 2.24 lakhs. The value could be lower if you take a higher inflation or a higher opportunity cost.

Abhi: You are getting into a lot of jargons. Just tell me what should I do?

Nicky: Take an informed decision. All other terms being same, with no intentions to default, or switch your lender and if you are sure that you will keep the loan for at least 15 years, then this scheme is for you. The benefit in present value terms is not as big as you think. But it is definitely a benefit.

On the other hand, if you think you might want to repay earlier or might want to change the lending bank sometime in the future, then this scheme may not benefit you and this scheme should not be the deciding factor for choosing a home loan provider.
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