RBI rate hike: Make part-prepayments, increase EMIs to cushion interest rise impact

Borrowers are a worried lot once again.

Not only has the Reserve Bank of India increased the policy repo rate by 25 basis points once again, but it has also left room for more hikes in the months to come.

Put simply, the interest burden on loans could mount further. This is especially true for home loans, which are linked to the repo rate, now at 6.5 percent. The RBI has cumulatively raised rates by 250 basis points (a basis point is 0.01 percentage point) since May 2022 and banks have passed on the entire hike to borrowers, pushing up their total interest payable.

Rates have hardened to a level where mere extension of the loan tenure – the default option instead of EMI hikes – to absorb the increased interest burden is no longer enough. EMIs are going up, too.

So, what can borrowers do to cushion the impact of the relentless rise in interest burden? In this edition of Simply Save podcast Moneycontrol’s Preeti Kulkarni spoke to Vipul Patel, founder of Mortgageworld, a mortgage advisory firm. Edited excerpts:

The RBI raised the repo rate again on February 8. What is your interest rate outlook for the coming months?

The RBI has been continuously raising interest rates since May 2022. The idea is to ensure that inflation is reined in. In the months to come, in this calendar year, we should expect an overall hike of another 25-50 bps. So, it will not be as bad as last year and will be done over the course of this year in smaller tranches.

So clearly, home loan borrowers need to brace themselves for a further increase in the interest payable…

The silver lining is that it will not be more than 50 bps this year.

Could you give a sense of how EMIs and interest payable on home loans have increased since May 2022, when the interest rate cycle turned?

So, when the repo rate was at 4 percent, most banks were lending at about 6.5 percent or thereabouts. So for a loan with an interest rate of 6.5 percent and tenure of 300 months, the EMI per Rs 1 lakh of loan was as low as Rs 675.

The rate of interest has now gone up to 8.85 percent in the case of many banks. The EMI per lakh has ballooned to Rs 825. The EMIs have risen by 20-25 percent, which is a big blow to existing home loan borrowers.

Also read: Increase home loan EMIs or tenure: What should borrowers do?

It has also impacted new homebuyers…

It has also affected prospective property buyers. If your salary is X and you were eligible for a Rs 50 lakh loan, you will now be eligible only for a Rs 37-38 lakh home loan. The purchasing power has shrunk and cashflows constricted. Those who really want to buy will have to put in additional efforts to garner the money required (to make the additional downpayment). People’s capacity to make purchases has been impaired, which is exactly what the government is intending to do.

Once demand is under control, prices will follow suit. So the move is positive from the long-term standpoint, but painful for consumers in the near-term. Those who are planning to buy new houses will have to postpone their decisions. If they are looking only at interest rates, then they will start coming down 15-18 months from now.

Also read: Looking for a new home loan? You may have to settle for a lower amount now

Interest rates and inflation are beyond consumers’ control. What can they do to reduce the interest burden with minimal strain on cashflows?

The most popular approach that is typically adopted is to increase EMIs. You can do so if your cashflows are robust. In India, salary increments have been in the range of 7-14 percent. Increasing EMIs by 10-12 percent can mitigate the impact of interest rate hikes.

Secondly, people who have traditional investments can use them to prepay part of the debt. You can part pre-pay this debt so that the interest burden can come down. You can also consider another strategy if your cashflows are constricted, though it may not work with all banks. Approach your bank to reschedule your EMIs in such a way that they remain lower for the next two years and can be adjusted during the future course of the loan.

At what point will it make sense to switch lenders?

Most banks are due for margin (spread over repo rate) reset. So, in 6-10 months, most banks will reset the limit. They might change the spread, or margin, by 25-30 bps. The lending is based on a credit score-linked mechanism. All banks will run credit checks – if yours has deteriorated, the interest rate will go up for you and vice-versa in case it has improved. (Due to these two factors) interest rates charged to some people will become costlier compared to others. Some banks’ loans will be more expensive than others. Any differential of 50 basis points should prompt you to look for options. Over long-tenure debt like home loans, long-term impact of 50 bps is a massive number.

Finally, has it resolved the longstanding grievance of existing borrowers? They often felt shortchanged when banks reduced interest rates only for new borrowers and did not fully pass on rate cut benefits to older ones…

To a very great extent, yes. The disparity, arbitrary pricing and lack of uniformity have been completely weeded out. Banks can charge higher margins, not lower. The minimum rate is now defined. Borrowers with high credit scores can negotiate hard with their lenders and switch out if they find better deals from other lenders.