Home Loan and Offset Loan Scheme

Have you ever heard of a self-destructing mortgage? Your interest expenses may be decreased by an offset loan program.

The MCLR is expected to aid in the quicker transmission of policy actions, but the agency stated that this is only possible if the lenders lower their deposit rates.

We all have the same goal in mind when it comes to home loans, reducing interest costs by making prepayments. Banks are also creating plans to aid borrowers in light of this. One such program is the offset loan, also referred to as the smart home loan program or home loan overdraft.

So, if you intend to take out a home loan and are looking for a wise option that will ultimately result in lower interest payments, you may want to think about an offset loan.

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A smart home loan is a service provided by banks that enables customers to deduct the interest on a home loan from the interest earned on money deposited in a specific loan account at the bank. In accordance with this plan, the borrower is required to keep an account for loans, which functions similarly to a current account but has an overdraft limit equal to the amount of the sanctioned loan. The borrower may place extra money in this account, withdraw funds at any time, and even use this sum to pay EMIs. For this account, banks provide a passbook and a debit card.

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Interest rate estimation

Typically, offset loans have interest rates that are 0.1–0.5% higher than standard loans. Only if the borrower maintains deposits above the threshold limit set by the bank is he eligible to use this facility. The interest on the loan is then calculated after deducting the outstanding loan from any additional savings kept in the account each month (over the EMI).

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If the EMI is Rs. 35,000 and the borrower has Rs. 50,000 in his account, for instance, Rs. 15,000 will be subtracted from the outstanding loan. In some cases, the bank specifies the minimum balance that must be kept in the account. For instance, Citibank has a Rs. 1 lakh minimum requirement.

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Shorter tenure and lower interest

Let's say a borrower is paying off a home loan of Rs. 50 lakh while maintaining a Rs. 1 lakh deposit after six months.

Then, the interest is determined on Rs. 49 lakh. If he keeps this deposit in the loan account for the duration of the loan, both the term and the total amount of interest paid on the loan are reduced significantly.

Assume that a smart home loan of Rs. 50 lakh was taken out at a rate of 10.50 percent for a period of 20 years, and that the borrower kept Rs. 1 lakh extra in his loan account throughout that time. As a result, he will pay off his mortgage in 227 months rather than 240. Over the course of the loan, he pays a total of Rs. 63.2 lakh in interest.

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He repays the loan in 240 months and accrues Rs 65.8 lakh in interest if he takes out a regular home loan for Rs 50 lakh at 10 percent for 20 years.

It is obvious that he has saved almost Rs 2.6 lakh in interest payments by taking out a wise home loan.

Interest savings increase as the interest rate differential narrows. If the interest rate is 10.2 percent, as in the example above, the smart loan option's tenure will be 228 months, with a total interest payment of Rs 61.2 lakh. This will save you about Rs 4.6 lakh compared to the regular option. The advantage of a smart home loan for the home buyers, however, disappears if the interest rate difference between a conventional and smart home loan is greater than 0.50 percentage points.

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Optional cost

The arrangement under the smart home loan involves an opportunity cost. In this case, you're keeping an extra sum in the loan account to cover the interest on the mortgage. Always consider the opportunity cost of keeping an amount locked in the loan account before deciding on such a course of action. In the aforementioned illustration, if the borrower had invested the funds in a fixed deposit with a bank that paid 8% interest annually, he would have made Rs. 4.6 lakh in 20 years. Therefore, before choosing an offset loan, always conduct a cost-benefit analysis.

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What is offset loan scheme?

Banks provide a service known as a "smart home loan" or "offset loan scheme" that enables customers to compare the interest on a home loan to the interest earned on money deposited in a specific loan account. As part of this program, the borrower is required to keep a loan account, which functions similarly to a current account but has an overdraft limit equal to the sanctioned loan amount. 

The borrower may place extra money in this account, withdraw funds at any time, and even use this sum to pay EMIs. For this account, banks provide a passbook and a debit card. Offset loans typically have an interest rate that is 0.1–0.5% higher than standard loans. Only if the borrower maintains deposits above the bank's specified threshold limit may he utilize this facility.  

The interest rate on the loan is then determined by deducting the amount of the outstanding loan from any extra savings that are kept in the account each month above the EMI.