This is a short post, because the bulk of the magic is in the Excel (Google Sheets) calculator linked at the end. This post merely provides some background information to help you make use / sense of those numbers.

What is a Home Loan Overdraft (HLO) account?

An HLO is a type of Home Loan that can potentially help you save a lot of money (under the right conditions). While the basics of HLO are the same as a “regular” home loan (aka Term Loan), there is one minor difference which can make a major impact on your interest payments.

One thing to note here that once you get a regular loan, your bank might not allow you to convert it to an HLO later (which is what happened with me), so do make sure you understand this before you get one.

How does it work?

First, for those who don’t know what Overdrafts are, let’s briefly go over those. Imagine that you have Rs. 5,000.00 in your Savings account, but you wanted to spend Rs. 6,000. You can’t do this with your Savings bank account, because you can’t have a minus 1,000 balance on a Savings account. An “Overdraft” solves this. Effectively, think of it as a pre-approved loan / negative-balance Savings account that you can withdraw from whenever you want. You will be charged interest for the duration for which you’ve withdrawn money, and interest charges will stop as soon as you’ve paid up. To summarize, the arrangement can be described as a combination of Savings (deposit / positive balance) + Overdraft (loan / negative balance).

Next, let’s try to understand Home Loan Overdraft (HLO), which is an Overdraft against a Home Loan. The main confusion you might have here is that a Home Loan is already a loan (i.e. negative balance). So is an HLO… an additional loan on top of the home loan? Nope.

The way I like to think of it is: “Overdraft means negative sign”. So HLO is negative of negative-balance, which is positive. Going by the previous analogy, this is the exact reverse - this is a Home Loan (negative balance) + Deposit Account (positive balance).

Why would you want this arrangement?

Effectively, you have some form of a “savings account” (that you don’t earn interest from) that’s attached to the Home Loan. How does this reduce your interest? It’s super simple - your EMI consists of both Principal and Interest components. You are charged interest each month based on your total outstanding balance on the home loan.

An HLO alters this equation very slightly. Your EMI stays the same, and you still pay interest, but the interest is calculated on the effective outstanding balance (that is, Outstanding Balance MINUS positive-balance-in-savings-account). So if you keep some money in your HLO Deposit account, you are saving interest on that much amount.

This is useful in the following cases:

• If you have lots of money lying idle in your savings account, it’s just earning 3.5-4% (as of today), whereas your home loan rate is higher. Putting it in there would help you not-lose money.
• If you make an unexpected windfall (inheritance / startup equity sale / etc), and you need a place to temporarily park some money, this is a great place to put it in.

Why not simply prepay?

This is also simple - if you prepay some amount, you can’t get that amount back. It’s permanently gone. But home loan interest rates are low, and you’re likely not purchasing homes all the time, so you’re likely not going to get capital at that low rate again. Giving up cheaper capital (and tax benefits!) just to save interest will cost you:

• Cashflow (you lose access to money)
• Opportunity cost (you lose the ability to opportunistically invest the money elsewhere that might help you earn more)
• Possible tax savings (I always discounted this, but I realized after making the below calculator how wrong I was. If you structure it correctly, you might even end up with a NEGATIVE interest rate in some years!!)

An HLO is a good middle-ground solution that allows you the best of both worlds.

Pros

• Possibility to lower interest
• Cashflow (Expenses/Emergencies) - Could use as an alternative to emergency funds you might be keeping in your savings account
• Cashflow (Opportunity cost) - Ability to invest elsewhere for higher gain
• Ability to continue home loan (which is cheap capital plus tax benefits)

Cons (and who should NOT opt for HLO?)

This sounds too good to be true! So what’s the catch? Two things:

• As you might imagine, banks don’t like losing interest, so they make it harder to avail this product. Not all banks offer HLO.
• Secondly, they charge a higher rate of interest (typically 0.25 - 0.5%) than your regular term loan

So you could stand to lose money if you never deposited anything. You should avoid an HLO if:

• your EMI is a very very high portion of your income (i.e. you won’t have money to deposit in the HLO)
• your income is stable but static (not expected to increase over time)

Calculator

Here’s a calculator I made where you can calculate what will actually work for you:

https://docs.google.com/spreadsheets/d/1rqKugDWEcnMEWWOvJpuSp7dOg-4RIIX8PlKiWc7MvfQ/edit?usp=sharing

Cheers! And happy house hunting!