You could be among the millions of Indians with an aspiration to own a home in your lifetime. You take all necessary steps to acquire that dream home of yours including availing a home loan from a bank such as IDFC FIRST Bank. Several important factors that you would have considered while taking the home loan would include the amount of loan, EMIs, interest rate and tenure. All these factors affect the repayment of the home loan in India.
The factor that is not under your control is the home loan interest rate. As you are aware, the RBI, in its bi-monthly policy initiative, decides to change the interest rate up or down and this affects the home loan interest rate charged by the lender on your home loan as well. If the interest goes down, you benefit because you will be paying out a lesser amount of interest while repaying the loan. On the other hand, if the interest rate goes up, then you pay more amount of interest. Typically, the lender allows you to maintain the EMI and decreases the tenure or increase the tenure as the case may be.
Thus, when the interest rate goes down, there is no need to change anything because you will benefit from the lower interest rate. However, your dilemma arises when the home loan interest rate increases. Then the cost for you goes up because you will pay more interest than what you would have paid if the interest remained constant.
What is the real effect of an increase in interest rates on your home loan parameters? You can check out the following points
Let’s assume that you are a salaried employee with a loan from IDFC FIRST Bank with the following terms
You calculated the EMI for the above particulars using the EMI calculator provided by IDFC FIRST Bank. Let’s assume that the loan has run for 10 years and there is still another 10 years for you to repay the loan. After 10 years your loan particulars are
Thus, you see that the EMI has increased from 26,992 to 27,513 which is an increase of Rs 521. Now this increase over 120 months would be Rs 62,520, which is the effect of increase of 0.25% in interest rate. Usually, your lender would just increase the tenure by two additional months (from 120 to 122 months) and retain the EMI. The outflow on the two additional months is Rs 53,984 (2 x 26992). The balance amount of Rs 8,536 would become payable along with the last installment. Thus, this increase of 0.25% should not bother you too much and you can continue the status quo.
You would recall that one of the features of a home loan in India is the prepayment option either partially or fully after the loan has run for a while. Usually, lenders charge a prepayment penalty for exercising this option. It is plausible that when the interest rate goes up and you have surplus funds, you tend to use the prepayment option as you don’t want to pay too much of interest in the future. To arrive at a decision to prepay or not, it is better for you to make a cost-benefit analysis. The analysis considering the parameters of the earlier example would be
Let’s assume you have surplus funds of Rs 3, 30,777 and you want to prepay this amount without any prepayment penalty. When you prepay, your new outstanding would be Rs 18, 00,000 (21, 30,777 – 3, 30,777). Using the EMI calculator, you calculate the EMI to be Rs 23,046.
Thus, you save Rs 3,946 (26,992 – 23,046) on EMI which is Rs 4, 73,520 over 10 years or 120 months
On the surface, this saving is great for you. However, you recall we had said that you should make a cost-benefit analysis before making the prepayment.
Suppose you don’t opt for prepayment but use the surplus funds to invest in an FD for 10 years with IDFC FIRST Bank at an interest rate of 8.25%, then you find from the FD calculator that at the end of the 10 year period you would earn Rs 4, 17,230 as interest. Of course, if you are a smart investor and trust mutual funds, you can earn much more than this as historically mutual fund investment outperform fixed interest securities.
Besides the above you could look at an alternative course of action that could include transferring your home loan to another lender bringing its own set of issues such as undergoing the home loan process all over again including incurring processing charges with the new lender, prepayment charges with the old lender and any withdrawal of tax benefits, if any on the old loan.
Finally, it is possible that the RBI could decrease the interest rate in the future and your home loan parameters get recast in your favour.
Based on the above analysis, you could make your own decision on your home loan in India as to how you want to react to the increase in interest rates.