Reserve Bank of India Recently, to control the rising inflation in the country, the repo rate has been increased by 50 basis points. With the latest hike, the repo rate is back to the pre-pandemic level of 5.40 per cent. This is the third consecutive repo rate hike by India’s central bank since May – an off-cycle rate revision of 40 basis points in May, followed by a 50-basis-point lending rate hike in June. Between May and August, the repo rate has been increased by 140 basis points.
Repo rate is the rate at which the Reserve Bank of India lends money to banks and other financial institutions. It is to be noted that all-floating rate retail loans sanctioned by banks after October 1, 2019 are linked to an external benchmark. For most banks, this is the external benchmark repo rate. An increase in the repo rate will increase the interest rates of home loans and personal loans linked to the repo rate. Marginal cost of funds-based lending rate (MCLR) and base rate-linked home loans will also become costlier as the borrowing cost of banks will increase after the repo rate hike.
“The increase in repo rates by RBI will lead to increase in interest rates for various products like home loans etc. This in turn increases the burden for the borrowers. Hence, borrowers will feel a pinch in their pockets,” said Sujay Das, chief risk officer, Freo.
To raise loan interest rates; Borrowers to feel the pinch
“Home loans and other retail loans linked to repo rates will see the sharpest transmission of policy rate hikes. Transmission will be faster for fresh floating rate retail loans,” said Naveen Kukreja – CEO and Co-Founder, Paisabazaar.
The exact date for transmission of enhanced policy rates to new home loan and other retail loan borrowers will depend on the rate reset dates prescribed by banks as per their guidelines. Kukreja said that for existing floating rate loans linked to repo rate, borrowers will be charged a higher rate from their interest reset dates.
Several banks including HDFC Bank, ICICI Bank, Punjab National Bank (PNB), Bank of Baroda (BOB), Canara Bank have already raised their lending rates after the RBI announcement on August 5.
What should home loan borrowers do now?
Extend EMI or loan tenure?
To mitigate the impact of rising interest rates, existing home loan borrowers can either take their Equated Monthly Installments (EMIs) or their loan tenure. “Note that opting for the tenure extension option will result in higher interest cost as compared to the EMI enhancement option,” Kukreja said.
For example, you have taken a home loan of Rs 30 lakh at 7.55 per cent per annum interest, with a tenure of 25 years. The EMI is Rs 22,267. After the latest rate hike by the Reserve Bank of India, the revised interest will be 8.05 per cent. At the new rate, you will have to pay Rs 23,254 for the EMI, so your EMI will increase by Rs 987 per month. The interest burden for the entire tenure will increase by Rs 2.95 lakh.
Now most banks prefer to extend the tenure of the loan keeping the EMI fixed. So, if the loan tenure is extended by 36 months, the interest burden will increase exponentially. Similarly, if the interest rate remains at 7.55 per cent and the prepayment period is extended by 3 years, the interest burden will increase by Rs 5.39 lakh.
prepayment of home loan
To save on rising interest cost, borrowers may consider prepayment option.” You should opt for the option of reduction in tenure.” Regular pre-payment will significantly reduce the outstanding loan amount.
Home Saver Option Is Here For You
Borrowers with limited liquidity can opt for the Home Saver option. Under this facility, an overdraft account is opened in the form of a current or savings account, where the borrower can park his surplus and withdraw it as per his financial requirements. The interest component of the home loan is calculated by deducting the balance in the savings/current account from the outstanding home loan amount.
Balance Transfer: Should You Go For It?
Another option may be to transfer the balance to a lender that offers competitive interest rates. In simple words, eligible borrowers can transfer their home loan to a bank that offers a lower interest rate than their existing lender. “Existing home loan borrowers who have seen significant improvement in their credit profile by availing their home loan should explore the possibility of interest cost savings through home loan balance transfer,” Kukreja suggested.
Remember that, this process involves additional costs such as processing fees or penalties for transferring the loan balance from one lender to another. Hence, borrowers need to calculate the advantages and disadvantages and savings before opting for balance transfer.
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