Home loan: Are you ready for a more expensive home loan?

Lower interest rates on home loans are always a lucrative proposition for property buyers. Over the past two years, there has been a sharp decline in the repo rate. Mortgage rates, now linked to the repo rate, also fell to historic lows.
But 2022 is seen as the year mortgage rates could start to rise again. To deal with a sudden spike in mortgage rates or tenure, do your financial planning carefully. Here’s how to handle it.

Where are the rates now
At its last monetary policy review meeting, the Reserve Bank of India (RBI) decided to keep the repo rates unchanged at 4% and the inverted repo rate at 3.35%. In fact, there hasn’t been a change in the repo rate since May 2020. Property buyers today can get home financing for less than 6.5% now, an all-time low, but that can’t not last forever.

The repo rate is basically the interest rate at which the RBI provides overnight liquidity to the banks. If it increases, home loans become expensive. If it goes down, loans become cheaper. Rates had already fallen to record lows of around 6.8% in December 2020, but continued to fall through 2021, with some lenders hitting 6.4%. As inflation rises, there may be no room for further cuts. Recently, a few financial institutions have increased their Fixed Deposit (FD) rates and home loans from some lenders have also become slightly more expensive. Borrowers should pay attention to these trends. Rising deposit rates also portend higher lending costs.

Check loan reference
From October 2019, RBI mandated banks to link loan interest rates to external benchmarks such as repo rate or treasury bill rate. Most banks have adopted the RBI repo rate as the benchmark for home loans. A repo-linked home loan has a more stable interest rate and is also easier for consumers to understand in terms of price, spread, and expected rate revisions. This was not the case with the old references.

Check your existing referral rates which may be higher due to which you pay a larger EMI or have a longer tenure. Talk to your lender and get the same in sync with the current repo rate.

Refinance a repo-linked loan
You can either choose another lender and refinance your existing loan, or ask your current lender to link your loan to the repo rate. Only banks offer repo-linked loans. Home finance companies may offer you the option of lowering your interest rate for a fee. If the rate change is large, say 50 basis points or more, you could potentially save thousands of rupees over the remainder of the loan term.

Let’s take an example, suppose you take a home loan of Rs 50 lakh at an interest rate of 7% for 20 years. For this loan, your total interest payable will be Rs 43,03,587. On the other hand, if the same home loan is to be paid at an interest rate of 7.5%, the total interest payable will be Rs 46,67,118.

Consider a single prepayment at the beginning of the year
Prepayment helps speed up your loan repayment. At the start of your loan, even one additional prepaid EMI can reduce the loan term by months, saving you hundreds of thousands of dollars. For example, for a 50 lakh loan taken out for 20 years at 7%,
prepaying 5% of the loan at the start of each loan year can help pay off the entire loan in 111 months instead of 240.
also reduces your total interest from Rs 43.03 lakh to Rs 17.7 lakh. You will need to follow the lender’s minimum prepayment rule. Some accept 1x your EMI, others may need 3x.

Increase EMI slightly if income increases
Once your monthly income increases, it is a good idea to opt for an increased EMI as it will reduce the overall term of your home loan and the interest will also decrease. You should choose to increase your EMI by a small percentage in order to save interest. The percentage increase should be decided based on the increase in your net income. The amount you pay in addition to your normal EMI will be adjusted based on principal, not interest. This then becomes a way for you to prepay your dues with smaller amounts instead of having to meet the minimum prepayment requirement.
Interest on loans is one of the biggest costs of home ownership, sometimes higher than the cost of the property itself. It must be mastered to minimize your costs. Smartly adjusting your loan repayment terms could lead to big savings.

The author is CEO, BankBazaar.com