The next monetary policy meeting is just a month away, and RBI is expected to hike the repo rate again, which means lenders will further increase the equated monthly instalments (EMI) of borrowers. Rising inflation levels often lead to higher interest rates. RBI increases the repo rate to control higher inflation, and when the key policy rates go up, loans, including home loans, will also go up.
Those who are going to apply for loans may have to end up paying higher EMIs as the banks would charge higher interest rates for new loans. The existing borrowers, especially those who have opted for flexible interest rates, would end up paying higher EMIs too.
Due to the increase in the interest rate, your monthly EMI outgo on your loan will also increase. In a case of higher interest rates, how best can you manage your finances?
Either, you can increase the tenure if you want to keep the EMI same as before, or you can increase the EMI outgo if you can afford to pay the extra EMI each month. You could also attempt refinancing your outstanding loan with another lender at a lower rate of interest.
Increase the tenure
A home loan borrower with an outstanding principal of Rs 40 lakh and tenor of 20 years at 7% interest could extend their tenor by 15-18 months when interest moves up to 7.4%.
The general practice when interest rates are higher is to revise the tenor of the loan instead of the EMI. An increase in the interest rate would mean a longer tenor at the same EMI. This means you would need more time to close your outstanding loan.
“Basically if the EMI is the same, your loan tenure goes up as shown in the graphic below. Most often, this is the default option your bank will follow. They will keep your EMI the same, and increase the period as that would be most beneficial for them since they earn more at your expense!”, explains Chaitali Dutta, personal finance and wellness expert.
Graphic by Chaitali Dutta
Make partial prepayments
If you have the funds, pay a part of that to keep the period and the EMI the same. That way your interest cost will not go up too much. If you got a bonus at work, or dividends from your investments, use that to part pay your loan.
“Long-term loans like home loans allow you to make prepayments. Since most home loans are now on floating interest rates, you don’t need to pay the penalty for prepayment. Your best alternative is to try to prepay your loan. While prepaying 5% of your outstanding every year would be an optimal solution, even a small prepayment of one EMI per year can bring substantial savings. Moreover, one needs to be financially disciplined during high inflation. It would be best to cut down your non-essential expenses, such as eating out too often or buying expensive gadgets that might not be your priority. Diversify your investments and avoid hasty decisions,” said Adhil Shetty, CEO, Bankbazaar.
“Your next best option is to request the bank to increase your EMI, to keep the interest scale up low.
Home loan savings account
One can also opt for a home loan saver option, which allows the borrower to deposit excessive savings in a saving account that is linked to the home loan account. The bank will autmatically deduct the balance of the savings account from the oustanding loan amount, and then calculate the interest. The surplus fund parked in this account acts like a prepayment against the outstanding principal.
” Under this plan, your Home Loan Account is a Money Saver Account, where you deposit funds; your savings, bonus, increment, etc. The funds parked in the Money Saver Account reduces the interest amount, as interest is calculated on a daily basis on the difference between the principal outstanding of your Home Loan and the funds maintained in the Money Saver Account,” said ICICI Bank.
For instance, if your outstanding is Rs 40 lakh and you have parked Rs 8 lakh in the overdraft account for three months, then the bank will charge interest on Rs 32 lakh for those three months, which will lower the total interest outgo.
You can also opt for home loan balance transfer at competitive interest rate
According to Bankbazaar, one can also opt for home loan balance transfer if he/she finds that the interest rate on his/her home loan is proving to be a burden. You can always move to another lender to refinance your home loan at lower interest rates than the existing rates. Most lenders offer home loan balance transfer at competitive rates. Hence, it is advised to find the one that does not hurt your monthly budget. Once you’ve opted for a balance transfer, your new lender will clear your entire outstanding loan amount with your previous bank. Your existing lender will release your property documents and no due certificate only after the entire balance amount is paid.
And lastly, plan your monthly budget more carefully
Currently, interest rates are still at historic lows with home loans starting from 6.5%, car loans from 7% and personal loans from 9%. But the era of low interest rates has now come to an end, which means one has to manage their finances better
“When inflation is high and loan rates are going up it is important to keep an eye on the budget more carefully. There might be a need to cut down discretionary purchases so that the overall cash flow that goes toward spending and loan repayment remains in check and so that savings and investments continue to be maintained,” said Rishad Manekia, founder of Kairos Capital.