Rising equated monthly instalment (EMI) is giving sleepless nights to many home loan borrowers. This is because the Reserve Bank of India (RBI) has increased the repo rate by 0.9 per cent since May 4, 2022. Banks have also passed on the entire rate hike to customers leading to a rise in borrowing costs. A borrower who took out a home loan at 6.72 per cent is now paying 7.62 per cent leading to higher home loan EMIs.
For people living on a tight budget, there might be more surprises in store as the three-day Monetary Policy Committee (MPC) meeting of RBI is scheduled to start on August 3 with the RBI governor Shaktikanta Das and other MPC members present. With high inflation rates, experts say interest rates are expected to increase further, and may reach upto 35-50 basis points.
“Domestic liquidity has reduced significantly in the past fortnight averaging about 1 lakh crores (likely due to RBI intervening in FX markets). Commodity prices have come off the peaks and crude has been trading near $100. With supply-side issues waning, the upside risks to CPI have eased off a bit. However, the US Fed has raised rates by 75bps again (with the likelihood of a similar hike in the next meeting) and continues with its balance sheet reduction program. RBI has stated that it is looking to move towards neutral to positive real rates and given CPI estimations, a rate hike of 35-50bps in the forthcoming policy is likely, albeit with a less hawkish commentary,” explains Anand Nevatia, Fund Manager, Trust Mutual Funds.
If the repo rate increases, it will lead to a longer tenure or higher EMI for home loan borrowers. When the interest rate increases, the default option for banks is to increase the tenure of a loan 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 7.65 per cent interest, could see the loan period further extended by two years assuming the interest rate moves up by 0.50 per cent to 8.15 per cent Not just the burden of increased tenure, the borrower also bears the brunt of extra interest outgo—Rs 10.14 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 42,289 compared to the earlier EMI of Rs 40,739, assuming interest rates increase by 50 basis points. 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.”
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