Home Loan Rates are Rising. Here’s What You Need to Do

Noida-based Jyotika Sharma bought her dream home last year. Property prices were low and the 30-year-old interior designer spared no expense for her dwelling—from a modular kitchen to state-of-the-art bathroom fittings to vibrant wall colours to the latest home appliances, she had it all. Her well-appointed home filled her heart with happiness. Now, it is giving her sleepless nights. Reason: Rising equated monthly instalments (EMIs).

Why are EMIs rising? The trigger was the Reserve Bank of India (RBI) increasing the repo rate by 0.9 per cent since May 4, 2022. Banks have passed on the entire rate hike to customers, amid a rise in borrowing costs. For her home loan, Sharma used to pay interest at 6.72 per cent when she bought her property; now she is paying 7.62 per cent. This has led to her home loan EMIs rising. “I was not expecting interest rates to move up so quickly. I am already [living] on a tight budget. The rise in EMIs makes me jittery about future expenses,” says a worried Sharma.

The silver lining is that the value of her house has appreciated significantly; but that doesn’t help since she isn’t selling. As the rise in interest rates brought major financial upheaval, borrowers like Sharma have to decide on whether they should continue with the current EMI or increase their outgo. The answer is not so simple; paying a higher EMI would result in reduced savings or living on a tighter budget, while continuing with the same instalment means a longer tenure and higher interest outgo. What should one pick?

The Strategy

Normally when interest rates go up, the tenure of a loan is adjusted in a way that the EMIs remain unchanged, but the number of years for payment increases proportionately. For example, an existing home loan borrower with an outstanding principal of Rs 50 lakh and tenure of 20 years at 6.75 per cent interest could see the loan period extended by three years and five months when the interest rate moves up by 0.9 per cent. Not just the burden of increased tenure, the borrower also bears the brunt of extra interest outgo—Rs 15.41 lakh to be precise in this case.

Another option is to pay a higher EMI while sticking to the ongoing repayment schedule. For this, one needs to put in a request with the lender as it is not a default option. For instance, on a loan of Rs 50 lakh for a tenure of 20 years, one will have to pay a revised EMI of Rs 40,739 compared to the earlier EMI of Rs 38,018. But before increasing your EMI outgo make sure that you do not exhaust all your savings, as this could pinch you in the long run.

So, which one is better—higher EMIs or a longer tenure? If you are already living on a tight budget, it is better to increase the loan tenure without hurting your savings and spending. If you have a surplus amount but still choose to increase the tenure, make sure you invest the surplus for generating higher returns. Why? V. Swaminathan, Executive Chairman of loan distribution company Andromeda Loans, explains: “If a borrower chooses to increase the repayment tenure of a loan, he/she can save the extra amount and use it to repay another loan or invest it for a higher return which will balance out the increased interest burden.”

Currently all banks benchmark their new loans against external benchmarks such as the repo rate—as directed by the RBI—after several complaints that they were not fully passing on the benefit of the rate cuts to borrowers. Any change in the repo rate has a direct bearing on your loan EMIs.

If you have a lump sum amount, you can opt for prepayment—an option to repay loans before the actual repayment tenure. However, before prepaying, do consider that you also let go of the tax benefits that you avail on home loans. For example, there is a deduction of Rs 2 lakh under Section 24 of the Income Tax Act towards interest payment, which is over and above the 80C deduction limit of Rs 1.5 lakh towards principal payment. Moreover, 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. Hence it is a trade-off and one has to decide as per convenience, considering prepaying a home loan brings a lot of mental peace.

If you have taken a loan from non-banking financial companies, chances are that your loan is an expensive one. In such cases, look at refinancing or restructuring for lower interest outgo over the repayment tenure. However, for refinancing, you need to understand the pros and cons. “In case one wants to shift to a new financier, one needs to calculate the net savings. There will be charges like processing fees, valuation and administration fees depending on the financier one chooses. One also needs to check the interest rates and the benchmark it is linked to in order to understand the long-term impact on the loan. Needless to say, there would be additional documentation and visits to your existing financier to get 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 one switch to fixed home loan rates? “As the interest rates show no signs of any reduction in the near future, the existing home loan borrowers can consider availing or transferring their floating-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 coming years. Later, when other economic factors like inflation and interest rates normalise, borrowers can avail another transfer and convert these fixed-rate loans into floating rates as per their convenience,” says Andromeda’s Swaminathan.

Of course, there are factors to consider before making a switch. If you’re 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 rise. “On the other hand, if you’re trying to minimise the amount of interest you pay on your loan, a flexible-rate loan may be a better fit. With a flexible-rate loan, your interest rate will fluctuate along 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 a personal one. Talk to your lender about your options and see what makes the most sense for your situation,” says Atul Monga, CEO and Co-founder of BASIC Home Loan, a home loan fintech company.

The Future

Demand for home loans has been good for the past two-three years because of the prevailing low interest rates. According to data from National Housing Bank, outstanding housing loans in FY21 surged to Rs 21.76 lakh crore from Rs 20.02 lakh crore in FY20—a growth of 8.68 per cent. However, the growth momentum might slow down now, as homebuyers may postpone their purchase decision amid rate hikes. “This could have a direct impact on the demand for home loans, as potential borrowers may now think twice before taking one. However, it is important to remember that the RBI rate hike is just a marginal one,” says Monga.

However, Akhil Saraf, Founder and CEO of Reloy, a real estate digital amenities provider, disagrees. According to him, even after an increase of up to 50-100 basis points, from sub-7 per cent a couple of months ago, interest rates are expected to remain within the comfort zone of below 8 per cent per annum. “With other factors and market conditions in favour of homebuyers, sales momentum is expected to continue without any major hiccups,” he says.

Considering that further rate hikes are very much on the cards, the advice is to prepay your costly loans first and go with banks with higher CASA ratios, as they are comparatively slower in passing on the rate hike to customers.

As for Sharma, she’ll have to pick what works best for her. That’ll set her up for financial stability, and of course, some restful sleep.

@teena_kaushal