Home Saver Home Loan - Watch Out!

This is my understanding of how the Home Saver loan operates (as against what is told to you when the loan product is sold).

Standard Chartered bank (SCB) offers Home Saver home loans where the home loan is linked with a Current Account where the borrower could deposit money. The interest to the extent of the deposited money will be waived (or what is called as interest saved). This is good because you'll save significant interest. However, there is a catch. The deposits are never treated as the payments towards the principal. This implies that your principal outstanding reduces at the same rate as it was with your normal loan.

For example: if you had taken a loan of Rs 10 lakhs, with an EMI of 10000 per month. For simplicity of calculation, let us say that the EMI comprises of Rs 9000 towards interest and Rs 1000 towards principal. Now, you made 2 lakhs in cash deposits in the linked current account. This deposit will make your interest payments go down. So if you're paying your full EMI of Rs 10000 per month then, your principal component is Rs 1000, your interest savings is Rs 2000 (approximately), this interest savings should go to the principal.

Going to an extreme case, let us say that you had deposited Rs 10 lakhs in the bank account (you could have cleared the loan - however, you wanted to have an option of taking that amount as liquid cash for you to use for other purposes - if required). This means that no interest is being paid. Ideally, since the EMI is being paid, all EMI must go to the principal.

The above story looks appealing. However, this is not how real computations might be happening. The real computation could be as follows. The EMI payment is taken as the actual EMI minus the interest saved. So, the principal deduction is very small, and happens at the same rate as if it is a normal loan. The interest savings are tracked. What effect does this have? The assumption that your full EMI is being deducted from the current account is *WRONG*. If your full EMI was deducted then the principal outstanding should have reduced rapidly because "full loan amount" is in the current account. However, since this does not happen, and the principal outstanding moves down slowly, if you'd want to close the account after few years, you'd still have a large principal outstanding. In the above example, when you have 10 lakhs in the bank account, the principal outstanding decreases (approximately) at Rs 1000 per month. Thus, after two years your principal outstanding goes down by Rs 24000. However, you'd have expected it to go down by 2.4 lakhs assuming that the entire EMI would go to the principal outstanding because you need not pay any interest. So, if you're planning to close a loan after two years, the 2.5% penalty will be applied on 9.76 lakhs (instead of 7.6 lakhs). This is a significant loss because you'd be paying an excess of around 2.5% penalty on approx. Rs 2 lakhs.

Note: Many other banks also offer similar home loan product. Most likely, they also operate the same way.