Noida-based Jyotika Sharma bought her dream house last year. Property prices were low and the 30-year-old interior designer spared no expense for her home – from a modular kitchen to state-of-the-art bathroom fixtures and vibrant wall colors and the latest appliances, it had it all. Her well-appointed home filled her heart with happiness. Now it gives him sleepless nights. Reason: increase in equivalent monthly payments (EMI).
Why are NDEs increasing? The trigger was that the Reserve Bank of India (RBI) raised the repo rate by 0.9% since May 4, 2022. Banks passed the entire rate hike on to customers, in a context of rising borrowing costs. For her home loan, Sharma used to pay interest at 6.72% when she bought her property; now she pays 7.62 percent. This led to the increase in EMI from his home loan. “I didn’t expect interest rates to rise so quickly. I’m ready [living] on a tight budget. Rising EMI makes me nervous about future expenses,” Sharma says worriedly.
The bright side is that the value of his house has appreciated considerably; but that doesn’t help since she’s not selling. As rising interest rates have caused major financial upheaval, borrowers like Sharma must decide whether to continue with the current EMI or increase spending. The answer is not so simple; paying a higher EMI would result in reduced savings or a tighter budget, while continuing with the same payment means a longer term and higher interest expense. What to choose?
The strategy
Normally, when interest rates rise, the term of a loan is adjusted so that the EMIs remain unchanged, but the number of years in payment increases proportionally. For example, an existing home borrower with an outstanding principal of Rs 50 lakh and a term of 20 years at 6.75% interest could see the loan period extended by three years and five months when the interest rate rises by 0.9%. Not only the burden of increased tenure, the borrower also bears the burden of additional interest – Rs 15.41 lakh to be precise in this case.
Another option is to pay a higher EMI while adhering to the current repayment schedule. For this, you have to make a request to the lender because it is not a default option. For example, on a loan of Rs 50 lakh for a term of 20 years, one will have to pay a revised EMI of Rs 40,739 compared to the previous EMI of Rs 38,018. you not to deplete all of your savings, as this could pinch you in the long run.
So which is better – higher EMIs or a longer tenure? If you’re already living on a tight budget, it’s best to increase the term of the loan without hurting your savings and spending. If you have a surplus but still choose to increase the tenure duration, be sure to invest the surplus to generate higher returns. Why? V. Swaminathan, Executive Chairman of loan distribution company Andromeda Loans, explains: “If a borrower chooses to increase the repayment term of a loan, they can save the extra amount and use it to repay another loan. or invest it for a higher loan. yield which will compensate for the increase in the interest expense.
Currently, all banks are pricing their new loans against external benchmarks such as the repo rate – as reported by the RBI – after several complaints that they were not fully passing on the benefits of rate cuts to borrowers. Any change in the repo rate has a direct impact on your loan’s EMIs.
If you have a lump sum, you can opt for prepayment, an option to pay off loans before the actual repayment term. However, before prepaying, consider that you are also giving up the tax benefits you get on home loans. For example, there is a deduction of Rs 2 lakh under Section 24 of the Income Tax Act for payment of interest, which exceeds the limit of deduction of 80C by Rs 1.5 lakh for the principal payment. Additionally, a home loan is one of the cheapest loans available, and by not prepaying, you can invest the money in assets that generate a higher return. It is therefore a compromise and must be decided according to convenience, since the prepayment of a home loan brings a lot of mental peace.
If you have taken a loan from non-banking financial companies, chances are your loan is expensive. In such cases, consider refinancing or restructuring to reduce interest over the repayment term. However, for refinancing, you need to understand the pros and cons. “If you want to switch to a new financier, you have to calculate the net savings. There will be fees such as processing fees, appraisal and administration fees depending on the financier one chooses. One should also check the interest rates and the benchmark to which they are linked in order to understand the long-term impact on the loan. Needless to say, there would be additional paperwork and visits to your existing financier to obtain the documents, which can add to the cost and effort,” says Murali Ramakrishnan, MD and CEO of South Indian Bank.
Fixed vs floating interest rate
Interest rates on home loans are on an upward trajectory. Should we switch to fixed mortgage rates? “As interest rates show no sign of reducing in the near future, existing borrowers may consider taking advantage of or transferring their variable rate home loans to fixed rate home loans. By transferring their loan, a borrower can save a good amount in EMI and interest payments in the years to come. Later, when other economic factors such as inflation and interest rates normalize, borrowers can take another transfer and convert these fixed rate loans to floating rates as per their convenience,” says Swaminathan of ‘Andromeda.
Of course, there are factors to consider before making a change. If you are looking for stability and predictability, a fixed rate loan may be the right choice for you. This can make budgeting easier and gives you peace of mind knowing that your EMI won’t go up even if interest rates go up. “On the other hand, if you’re trying to minimize the amount of interest you pay on your loan, a flexible rate loan may be more suitable. With a flexible rate loan, your interest rate will fluctuate with the market, which means your payments could go up or down over time. However, you may be able to get a lower interest rate when you first take out the loan, which could save you money in the long run. Ultimately, the decision to switch to a fixed rate loan is personal. Talk to your lender about your options and see what works best for you,” says Atul Monga, CEO and co-founder of BASIC Home Loan, a home lending fintech company.
The future
Demand for home loans has been good over the past two or three years due to low prevailing interest rates. According to National Housing Bank data, outstanding housing loans in FY21 jumped to Rs 21.76 lakh crore from Rs 20.02 lakh crore in FY20, a growth of 8.68%. However, the growth momentum may be slowing now as home buyers may postpone their purchase decision due to rate hikes. “This could have a direct impact on demand for home loans, as potential borrowers may now think twice before taking one. However, it is important to remember that the rise in RBI rates is only marginal. says Monga.
However, Akhil Saraf, founder and CEO of Reloy, a provider of digital real estate equipment, disagrees. According to him, even after an increase of up to 50 to 100 basis points, against less than 7% a few months ago, interest rates should remain in the comfort zone below 8% per year. “With other factors and market conditions in favor of homebuyers, the sales momentum should continue without a major hitch,” he says.
Considering that further rate hikes are quite possible, the advice is to pay off your expensive loans first and opt for banks with higher CASA ratios, as they are comparatively slower to pass on the rate hike to customers.
As for Sharma, she will have to choose what suits her best. This will ensure financial stability and, of course, restful sleep.
@teena_kaushal