What Should You Do With The Increase in Home Loan Interest Rate?
Inflation is rising. As a result, it was expected that the Reserve Bank of India (RBI) would take a harsh stance against inflation. RBI's monetary policy committee (MPC) hiked benchmark rates by 40 basis points at an emergency meeting in the first week of May. As a consequence, the current repo rate stands at 4.4%.
Some banks raised their external benchmark lending rate as a consequence of the rise. Interest rates are expected to climb by over the next two years, according to experts. Borrowers who are already making loan payments would have to raise their EMIs or face a longer repayment period. This will put them under even more strain.
If you have a house loan and are unsure how to manage your EMIs, look at the three alternatives below:
Prepayment is your best bet
In the low-rate era, rates as low as 6.4 percent were available to borrowers who took out loans at around 9.5 percent. They may have refinanced at the lowest possible interest rate to slash EMIs and loan terms. New home-loan borrowers may feel the squeeze if rates climb. Rising interest rates entail higher EMIs and longer loan terms. For example, if the house loan interest rate rises to 10% from 9% per year, the EMI on a Rs. 50 lakh loan rises to Rs. 45,435 from Rs. 41,960. Thus, the total interest rise during a loan term of 25 years is Rs.10,42,566.
Prepayments help here. It minimises your interest load and EMIs. So, in addition to your EMIs, you may pay off your loan with a lump sum from a windfall, bonus, or other income sources. Home loan prepayments involve partial or full repayment while still servicing the loan. The principal, interest, and loan term are all reduced when you partially prepay your mortgage.
Be systematic with your prepayments
Rates are likely to climb by 200 basis points. Let's say interest rates rise by 100 basis points. In such instances, new borrowers may choose to seek debt relief by a systematic prepayment of 5% of the outstanding loan amount once every loan year.
Suppose you had a loan with a 20-year maturity date. If we assume a constant interest rate, you may be debt-free in 12 years.
By paying 5% of your prior loan amount, your monthly EMIs will cover almost two- thirds of your loan, making them more effective. This is a sound strategy since it enables you to prepay on a regular basis without jeopardising your other financial goals, such as retirement and children's education. As a result, you will get out of debt sooner and have more money to invest.
Timely prepayment
In the event of a rate hike, this is a pretty forceful stance. Your goal here should be to restore the tenure to where it was before the rate hike. Suppose you've been repaying a Rs 50-lakh loan with a 6.7 percent interest rate since May 2021. Your interest rate climbs to 7.1 percent after 13 EMIs. Your tenure will be increased to 243 months in June after being decreased to 227 months in May. You might reduce the loan length to 226 months by making a prudent prepayment of Rs. 175,000 in June. Together with your usual EMI, this prepayment will reduce your loan term to 226
months by July. If interest rates rise, you may repeat the procedure to complete the loan within the specified time frame. You will be in a better position if interest rates decline.
Your goal after taking out a house loan should be to service it on a regular basis. Your plan should be guided by the present interest rate and the pace of inflation. If interest rates are low, you may continue to pay your monthly EMIs and invest your extra money.
Keep track of loan rates and how they affect your EMIs and interest payments. Make the calculations required to determine which method is best for you. The concept is to take out a loan to achieve a financial goal while paying it off strategically to become debt-free sooner.
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