Switch if you can find 50 bps cheaper home loan; lock into current FD rates

Some lenders have lowered their rates over the past couple of months by reducing their spreads

The Reserve Bank of India (RBI) kept the repo rate unchanged at 6.5 per cent on August 10, choosing to look through the recent spike in consumer price index (CPI)-based inflation. However, it revised its CPI inflation projection for 2023-24 to 5.4 per cent, 30 basis points higher than the earlier figure. Moreover, it provided an estimate of 5.2 per cent for the first quarter of 2024-25, indicating that CPI inflation is likely to remain above the 4 per cent target rate for a considerable period. Experts say interest rates will remain on hold for a prolonged period and the first rate cut may only materialise towards the middle or the second half of FY25.

Home loan borrowers: Switch or prepay

With the repo rate remaining unchanged, borrowers whose floating rate loans are linked to external benchmarks won’t witness any increase in their equated monthly instalments (EMIs) or tenures.

“Those whose floating rate loans are linked to the MCLR (marginal cost of funds-based lending rate) and other internal benchmarks may witness a change in their loan rates, depending on the change in their internal benchmarks and the rate reset dates of their loans,” says Naveen Kukreja, co-founder and chief executive officer (CEO), Paisabazaar.

While the weighted average interest rate on existing loans has risen for 14 months in a row, fresh loan rates have been volatile. 

“Interest rates on fresh loans have, in fact, fallen in recent months, indicating banks’ intent to hold rates for customers where possible,” says Adhil Shetty, chief executive officer (CEO), BankBazaar.com.

The repo rate has risen from 4 to 6.5 per cent. “In March 2022, five large lenders offered rates of 6.5-6.7 per cent. The rates of three peaked at 9 per cent or higher in April 2023. Currently, four are lending at 8.4-8.6 per cent,” says Shetty. Banks have lowered rates by reducing the spread on their new loans from around 3 percentage points in 2019-20 to as low as 1.9 percentage points.

The difference between weighted average loan rates and fresh loan rates indicates that a significant percentage of borrowers are paying above-market rates. “Borrowers with good credit scores paying above-market rates should consider refinancing. They should check out the rate they can get currently,” says Shetty. If the difference between their current rate and the new one is 50 basis points or more, they should consider refinancing.

According to Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors, “Existing borrowers should channel any surpluses they get to part prepay their loans.”  

Lenders must take borrowers’ consent

In the past, there have been several cases of tenures on floating rate loans being hiked to an unreasonable extent. The RBI has proposed it will put in place a framework of conduct for lenders. They will have to communicate clearly with borrowers before resetting the tenure and/or EMI. They must also provide them the option to switch from a floating to a fixed-rate loan and foreclose their loans.

Many borrowers are not aware that an extension in tenure translates into a higher interest cost. “A mandatory consent from borrowers before the tenure increase will help them take an informed decision on whether to go for an EMI or a tenure increase,” says Kukreja.

Lock into current FD rates

The average interest rates on outstanding rupee deposits with banks have been rising consistently for 15 straight months. “This is a good time for customers to lock into the best available rates,” says Shetty.

If there is a gap between the rate you are getting on your current fixed deposits (FD) rates and those available currently (the best rates are in the one-three-year tenures), reinvest into a new FD after factoring in the cost of breaking your existing one.

Debt MFs: Stay at the short end  

Investors should keep the bulk of their debt mutual fund portfolios in shorter-duration funds. The yield curve is relatively flat at present. “Investors won’t get compensated adequately for taking higher duration risk,” says Dhawan. With rate cuts getting postponed, they are unlikely to make capital gains either. Dhawan says those opting for a longer tenure should go for target maturity funds to lock into yields.

Says Joydeep Sen, corporate trainer (debt markets) and author: “Investors should stick to the strategy of matching their investment horizon with the duration of the fund’s portfolio.”