I HAVE BEEN TOLD TO SAY…THIS IS A HYPOTHETICAL EXAMPLE – ANY resemblance of this to the real world should not happen..

Viewer: Sir I have a home loan of Rs. 45 lakhs payable over 20 years at a (floating rate) of 11.75%. A new Aggressive Bank is offering me a New Loan of Rs. 45 lakhs at a rate of 11%. However this will involve paying a 2.1% prepayment charges. What would you suggest?

Answer given:..You will spend about 90,000 as prepayment, but you will save about 0.75% p.a. for the next 20 years (=22,500 * 20 years) whereas you will pay only Rs. 90k as prepayment charges. So definitely worth it.

 

Will the readers pick holes in the story please?

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  1. Need to account for inflation or the decrease in the value of 22500 in the next 20 years.. 90K is something which you need to pay today, but 22.5K which you pay next year might be valued less today..

    Is this the hole?

  2. Did some more excel calculations.. the person will save some INR 5,56,560 in 20 years by switching from 11.75% to 11%. To convert existing INR 90,000 into that amount in 20 years will need a 9.54% CAGR. If you think your portfolio can give more than this (hopefully yes), then this a bad deal..

  3. yes both of you are right…cannot subtract 90k from 556,000 – and that is precisely what the anchor did! This is ridiculous. Also you do not save 0.75% *45L – simply because the interest is on the reducing balance method. Not sure whether it is lack of knowledge or a deep desire to increase transactions.

    Also did not consider a processing fee with the new lender…and again IT IS A FLOATING rate – is there a guarantee how the second lender will behave? NO.

    I rest my case 🙂

  4. Yeah – the reducing balance fallacy and the simple interest calculation – easiest mistakes in analysis. But people jump on because its make ‘decision making’ simpler 🙂

  5. Surely, TV has created a whole lot of ‘experts’. In the good old days, I remember most used to make their own calculations and /or discuss with friends as to what is the best available option in the market. What I see today is information (generally useless) thrust on TV audience which makes the viewer feel ‘high’ about becoming knowledgeable very easily and taking correct decisions. Disaster.

  6. I think the biggest hole is “aggressive bank”. Just as they will be aggressive in acquiring new customer by refinancing they will be aggressive in increasing the rate for existing customers. (Read ICIxx, HxFx).
    “Thank you for banking with XXXX bank. Your interest rate is increased by 1% and you are in deeper soup”. These letters are ready with them all the time. They just wait for month or quarter to get over. 🙂

  7. En lighting Q&A, I planned to get Rs.10 Lakhs as housing loan from one of the nationalized bank. Every home loan buyer was taking about this “benefit”, which i disagree. [ without even analysing like the above Q&A ] because they are in business, they have targets for this month, this year. but my house is for me, for my child, for my grand children.
    Thank you very much Anshuk and Subramani

  8. Dr Mohammed Ali Khan

    @ Jayant
    I agree with you
    Bankers, by definition should be plain boring people..
    Be vary of the “aggressive” ones..

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