RBI Monetary Policy | Borrowers to see a steep hike in EMIs, interest burden

Brace yourselves for a steep increase in your equated monthly installments (EMI) and interest burden on loans.

Reserve Bank of India Governor Shaktikanta Das on Wednesday announced a 50-basis points (100 basis points = one percentage point) hike in repo rate, close on the heels of the 40-bps off-cycle increase announced on May 4. The repo rate now stands at 4.9 percent. The primary factor responsible for steep hikes as well as RBI’s hawkish stance is the raging inflation in the country.

“The CPI headline inflation in April registered a further sharp increase to 7.8 percent. It was the fourth consecutive month when inflation touched or was above the upper tolerance level of 6 percent,” Das said in his statement.

Also read: RBI’s 40-bps hike in May: How it affects borrowers and depositors

Loans turn expensive as EMIs, interests set to spike

After a prolonged period of benign interest rates, borrowers will now have to get used to paying higher EMIs, besides paying more for products and services that they consume due to soaring prices.

Since all floating-rate retail loans sanctioned after October 1, 2019, are linked to an external benchmark, which is repo rate in case of most banks, the transmission will be quick. “Most home loans are floating rates, and they will be hit hard with this second upward revision in less than a month’s time. The repo-linked floating rates will see almost immediate transmission over the next few weeks. The MCLR-linked rates may take a little longer, but the transmission will occur,” says Adhil Shetty, CEO, Bankbazaar.com.

Personal and car loan borrowers, however, need not be as concerned as home loan borrowers. “Most personal loans and car loans are fixed rate loans, and existing borrowers may be able to continue at the current rates for the rest of their tenor so long as there’s no clause that allows the lender to reset the rates periodically,” Shetty adds.

With a cumulative increase of 90 basis points in repo rate since May 4, a lot of money will be sucked out of the system, making borrowing and consumption expensive for all. “So, if someone was eligible for a loan of Rs 1 crore prior to May, now this figure will come down to around Rs 80 lakh. This is because your loan eligibility is a directly linked to your EMI paying capacity,” says Vipul Patel, Founder and CEO, MortgageWorld.com, a loan consultancy firm.

For example, let’s say your EMI per lakh was Rs 675 at an interest rate of 6.5 percent, assuming a loan repayment tenure of 300 months. Now, with the two consecutive hikes, it will go up to Rs 732. “Overall, this means that your EMI-paying capacity will shrink,” he adds.

Also read: How to cushion yourself against RBI’s rate hikes

Tough times ahead for borrowers

Home loan borrowers need to be prepared for tough times and decisions. Typically, banks extend the repayment tenure and not the EMI when rates go up, provided there is scope to do so. However, extension of tenure means higher EMI burden.

“Home loan interest rates which had bottomed out around 6.5 percent in April will now be inching towards 7.60 percent in June. The back-to-back repo rate hikes will make floating rate loan tenures longer. For example, say, a person had borrowed at 7 percent for 20 years. If the rate were increase to 7.5 percent, they would need to pay 24 more EMIs,” says Shetty. In the same example, if the borrower were to opt for EMI adjustment instead, the EMI per lakh would increase by Rs 30.

“In essence, the monthly outgo would increase by about 4 percent. The math is different for each borrower. The key is to pay off the loan in the intended timeframe,” he adds.

As the quantum of hikes (90 bps within two months) is huge, there is very little to room to take measures to mitigate the impact. Moreover, RBI’s hawkish stance indicates that more rate hikes could be in the offing. If you can afford to, you should, in fact, look to increase your EMIs to reduce the overall interest burden. A lump-sum part-prepayment will offer limited help in mitigating the rate hike impact.

“Prepayment may not be the option for many if you want to retain the same EMI and overall interest throughout the tenure. This is because, to do so, you will have to prepay a huge sum. For example, on a Rs 1-crore home loan with a 25-year tenure, you will have to prepay close to Rs 4.38 lakh to mitigate the impact of this 50 bps hike,” says Patel. And, to blunt the effect of the cumulative 90 bps hike, you will have to prepay a whopping Rs 7.82 lakh at one go.

A combination of both – lump-sum part-prepayment and increasing EMIs voluntarily – could help reduce the interest burden. “Borrowers may use pre-payment methods such as EMI step-ups or lump-sum payments to control their interest burden,” says Shetty.

Higher rates for depositors

For depositors, on the other hand, RBI’s stance and substantial rate hikes have finally put an end to the prolonged low-return rate scenario. “The hike in deposit rates will happen in tandem over the next few weeks. While the entire hike may not be transmitted, depositors can expect the FD rates to go up over the next few weeks,” says Shetty. However, with CPI inflation of 7.8 percent, their real returns will remain muted.