Prepay home loan to combat interest rate hike impact, say experts

If your pocket allows, opt for higher EMI, not a longer tenure

The Reserve Bank of India (RBI) hiked the repo rate by 35 basis points (bps) on Wednesday. This benchmark rate has risen 225 bps between May and December this year. Home loan rates (for loan amount of Rs 30-75 lakh) are in the range of 8.25-10.5 per cent for most players. Borrowers, both existing and new, will feel the brunt of the latest rate hike soon, given that a large percentage of home loans are linked to an external benchmark, mostly the repo rate, nowadays.

In fact, in a communication on Wednesday, Bank of India said, "...this is to inform that Bank's Repo Based Lending Rate (RBLR) has been changed to 9.10% with immediate effect... The revision is on account of upward revision in Repo Rate announced by RBI..." It is expected that other banks and non-bank lenders are also likely to raise their rates for borrowers in the coming days.

Impact on interest payable and tenure

Let us take an example to get a sense of the impact of this rate hike cycle on home loan borrowers. Take the case of a home loan for which the interest rate stood at 7 per cent in May. The principal amount was Rs 50 lakh and it had a tenure of 15 years (180 months). At that point, a person taking this loan would have paid an equated monthly installment (EMI) of Rs 44,941. The total interest burden on the loan over 15 years would have been Rs 30.89 lakh.

Now, the interest rate on this loan would be 9.25 per cent. The EMI on this loan would now be Rs 51,460 (up Rs 6,519). The total interest payment over a 15-year tenure would now be Rs 42.63 lakh, an increase of Rs 11.73 lakh.

Imagine a situation where the EMI is kept constant but the loan tenure is increased. With the interest rate rising to 9.25 per cent, it would rise from 180 months to 254 months, an increase of 74 months (six years and 2 months). The total interest payable on this loan would rise from Rs 34.6 lakh to Rs 64.13 lakh, an increase of Rs 33.23 lakh. In other words, the interest burden would almost double.

Demand may sustain

Experts say housing demand, which has been strong in recent times, may sustain despite the steep increase in home loan rates. “As long as interest rates remain in single digit, the impact on housing demand will, at best, be moderate,” says Anuj Puri, chairman, ANAROCK Group.

He adds that the housing market is currently end-user driven, and the latter don’t look for the lowest entry point but wish to enjoy the inherent benefits of home ownership.

Don’t time entry

Buyers who plan to take a home loan won’t gain much by postponing, given that property prices are also on the upswing. High current rates have an upside. “They will borrow at almost the peak of this rate hike cycle. Over the next few years, interest rates are likely to either remain stable or come down,” says Adhil Shetty, chief executive officer (CEO), BankBazaar.com.

Trying to time the home loan is futile since this is a long-term liability during which borrowers can’t avoid facing adverse interest-rate movements a few times.

New home loan borrowers may opt for the home saver option (also called Home Advantage, Maxgain, Maxsaver etc). Under this facility, the lender opens an overdraft account, a savings or current account, for the borrower. Borrowers can park their surpluses in this account and make withdrawals according to their requirements.

“The interest component of a home loan is calculated after deducting the amount parked in the overdraft account from the outstanding principal. Thus, this facility allows the home loan borrower to derive the benefit of making prepayments without sacrificing their liquidity,” says Naveen Kukreja, CEO & co-founder, Paisabazaar.

Develop prepayment plan

When their interest rates are increased, existing borrowers should opt for the EMI increase option, with their lender’s consent. “Opting for the EMI increase option will result in lower interest cost than the tenure increase option,” says Kukreja. Only if you have financial constraints should you increase the tenure rather than the EMI. 

Also develop a pre-payment plan. “Develop one that you can adhere to, and which is also in sync with what your lender allows,” says Shetty.

Borrowers who have seen a significant improvement in their credit profile after availing a home loan can go for the home loan balance transfer option to reduce their interest cost. “Their improved credit profile may make them eligible to transfer their existing home loan to another lender at a much lower interest rate,” says Kukreja.