Reserve Bank of India (RBI) repo rate hike: After trending at multi-decade lows, home loan interest rates are rising again. This is because the Reserve Bank of India has raised the key repo rate by 50 basis points in its latest policy review to tame spiraling inflation. The repo rate now stands at 5.4 per cent. This was the third straight rate hike after the Reserve Bank of India raised the key rates by 40 bps and 50 bps in May and June, respectively.
Most experts believe this is not the end of the rate hike cycle. Given the expectation that inflation will continue to be more than the RBI’s tolerance level, the central bank may increase the repo rate by 0.5 per cent in October. As a borrower, you should be prepared to deal with these hikes.
Home loans issued since October 2019 are linked to the repo rate. Whenever the repo rate is revised, the home loan rate will be revised by an equal margin, typically once a quarter. Normally, this rate change translates into a tenor adjustment. For new borrowers, as rates rise, loan tenors will get longer. A total rate hike of around 140 basis points so far, with more to follow in October, means that new borrowers would have to pay dozens of more EMIs.
To make repayment easy and rate changes manageable, banks normally don’t change the EMI during a rate change. Only the tenor changes. As a result, you don’t feel the financial burden, and the additional interest is paid over a longer tenor while your EMI remains constant. But as a borrower how to manage your EMI burden after the hike? Here are a few steps you can take:
Pre-payment is an effective way to reduce the tenure, outstanding principal and overall interest outgo. You can use any surplus money such as increment, bonus or any other windfall to make a bullet payment against your loan. Your regular EMIs payment continues simultaneously. Home loan pre-payments allow you to repay your loan partially or completely during the loan service period. For example, if you have a Rs 30 lakh loan at 7.4 per cent for 20 years, your EMI would be Rs 23,985. After the revision, your home loan rate would be 7.9 per cent and your total interest would revise to Rs 29.77 lakh. However, if you keep the EMI the same, your tenor for the loan will extend by 24 months after a rate hike. You have to estimate in this example how much pre-payment would help you erase the 24-months of additional EMIs. Once your original tenure is back, you can continue with your regular EMI payments. If the rate lowers in the future, you will be better positioned to get rid of the debt.
If you are at the beginning of your loan tenure, you may consider a systematic approach to reduce the loan by pre-paying 5 per cent of the outstanding loan amount once every loan year. For instance, if your loan is for 20 years, pre-paying at least 5 per cent of your outstanding amount at the same interest rate would bring down your loan tenure to 12 years. With this, payment of your regular EMIs would ensure nearly two-thirds of your loan is paid off.
If your finances permit, you can go for higher EMIs payments. This will instantly reduce your interest outflow. For instance, if you pay Rs 30,000 as EMI, but you decide to pay Rs 40,000 in a month, the extra Rs 10,000 would be adjusted against the principal. This will accelerate your EMIs payment every month and help you be debt-free faster.
You can switch to a lower rate to reduce your EMI outgo. However, before doing so, compare the available rates and the costs involved. You will have to shell out a nominal processing fees if you switch to a lower rate with your current lender. If you opt to refinance with a new lender, you will have to pay stamp duty charges and processing fees. So do your maths to know if refinancing helps in actual savings. Another great way to reduce your loan burden is, when you refinance to a lower rate, continue to pay the same EMI amount so that you pay off your debt faster. Remember that refinancing only helps when you have over half your loan tenure.
A loan helps you in accomplishing your financial goal. However, when you take one, your objective should be to pay it off in an optimal timeframe to be debt-free and have more money for savings, investments and the fulfillment of other aspirations.
The author is the CEO of BankBazaar.com. Views expressed are that of the author.