Home loan EMIs set to go up as interest rates bottom out: What borrowers should do

There are indications of borrowing costs finally bottoming out. For instance, interest costs for new SBI home loan borrowers went up by 25 basis points recently after the bank withdrew its ‘limited period offer’ and restored original interest rates. The new SBI home loan rates from 1 April start at 6.95%, compared to 6.7% till 31 March. It could well be that other lending entities will soon follow suit.

“Though impact of incentive withdrawal is just 25 basis points, it may have a system-wide impact because other financial institutions usually follow SBI with a time lag,” says Naveen Kukreja, CEO & Co-founder, PaisaBazaar.

HDFC, India’s mortgage industry leader, increasing interest on its fixed deposits by 10-25 basis points after a gap of 29 months is another indicator. Since this move will increase cost of funds for HDFC, its interest rates on loans have to follow suit. Other institutions follow HDFC and therefore, any loan rate increase by HDFC will also have a system-wide impact. Borrowers should be extra careful now. If not managed properly, rising interest rates will play havoc with your finances, because it will result in increase in loan tenure or EMIs. So what are the options available for new and existing borrowers?


For new borrowers
To make this analysis more meaningful, let us start with the options for new borrowers. As a thumb rule, fixed-rate loans are the best option in a rising interest rate scenario. “Since interest rates are bottoming out, this is the best time to take fixed rate car loans, personal loans, etc because borrowers can lock-in at lower rates,” says Adhil Shetty, CEO, BankBazaar.

New home loan borrowers are not that lucky because only a few institutions offer fixed rate home loans. High interest charged on fixed rates loan is another problem. “Since interest rates charged on fixed rate home loan are very high and not lucrative at all, it is better for new home loan borrowers to stick with variable rate options,” says Kukreja. For instance, LIC Housing Finance charges 10.05% for a Rs 50 lakh fixed rate home loan compared to just 6.9% for its variable rate variant. Though HDFC is offering fixed rate option at a small premium, it is not of much use because the interest is fixed only for the first two years.

Since floating interest rate is the only viable option for new home borrowers, they should be mentally prepared for rate increase in future and the resultant increase in EMIs. It makes sense to keep some additional cushion for this—it can be in the form of increased contingency fund or investments going towards non-critical goals which can be diverted in case of need.

For existing borrowers
In the event of interest rate increase, banks usually allow the option of increasing the EMIs or increasing loan tenure. Increasing loan tenure option, however, may not be available for all borrowers. “Since banks usually don’t allow the loan tenure to go beyond the original loan tenure or retirement of the borrower, a section of borrowers have no option but to settle for increased EMIs or keep the EMIs same by making upfront payments,” says Aparna Ramachandra, Founder & Director, Rectifycredit.com. Banks will offer automatic loan tenure extension for borrowers who have taken loans a few years back, when the rates were higher. In this case, the overall tenure might have come down due to subsequent fall in interest rates and banks will happily reinstate the original loan tenure.

Should you go for loan tenure extension if given the option? No, say experts. “If your monthly cash flow permits, keep the tenure same and ask for increase in EMIs. This will help you to bring down the total interest payout,” says Shetty.

Assume that you have just started servicing a Rs 50 lakh loan at an interest of 7% and paying an EMI of Rs 38,765. If the rate increases to 8%, your EMI will jump to Rs 41,822, an increase of Rs 3,057 per month. If you try to keep the EMI at Rs 38,765, your tenure will balloon to 24 years and 8 months. This additional payment period of 56 months will also increase your total interest outgo drastically —from Rs 50,37,280 (if paid in 20 years with an EMI of Rs 41,822) to Rs 64,71,280 (paid over 24 years and 8 months with an EMI of Rs 38,765), an additional interest outgo of Rs 14,34,333.

What to do if your current monthly cash flows don’t allow an increase in EMIs? Compare yield on all your investments and take a decision based on that. “Rather than parking money in low yielding instruments, redeem part of it and make some upfront repayments. Surrendering low yielding products like insurance endowment plans can be another option to raise money,” says Ramachandra.

Check for lower rates
Since we are getting into an interest rate flux, the interest rates offered by institutions may vary widely. So, compare the rates offered by other borrowers on a regular basis and make sure that you are getting the best rates. Should you try to shift if the rate offered by another lender is low, say 20 basis points? No. “Since loan switching involves costs, consider switch only when the difference between loan rates is more than 50 basis points,” says Kukreja. Please note, in addition to external costs like processing fee, stamp duty, etc, you also have to spend additional time for fulfilling those formalities.