What to do when Home Loan Interest Rates are on the Rise

If you are among the millions of Indians who dream of owning a home in their lifetime, you might take all the necessary steps, including availing a home loan from a bank like IDFC FIRST Bank. When you are considering a home loan in India, you would have considered the amount of loan, the EMIs, the interest rate and the tenure, all of which affect the repayment of the loan. Changing interest rates may have you wondering what impact it will have on your home loan. Let's see what it means for you.

Effect of changes in home loan interest rate
 

Home loan interest rates are a factor that you cannot control. As you are aware, the RBI, in its bi-monthly policy initiative, decides to change the interest rate up or down, which affects the home loan interest rate charged by the lender on your home loan as well. When interest rates go down, you save money because you pay a lower amount of interest while repaying the loan. However, when interest rates go up, you end up paying more. Lenders usually allow you to maintain your EMI and reduce or increase your tenure based on your needs.

In other words, if the interest rate drops, you don't have to do anything because you'll benefit from the lower rate. However, when the interest rate on your home loan increases, your dilemma arises. In this case, the cost increases for you because you will have to pay more interest than you would have if the interest remained the same.

What is the real effect of an increase in interest rates on your home loan parameters? You can check out the following points:

How much is the interest increase?
 

Let’s assume that you are a salaried individual with a loan from IDFC FIRST Bank with the following terms:

• Loan amount of Rs .30 lakh
• Tenure of 20 years (240 months)
• Home loan interest rate of 9% (floating)
• EMI is Rs. 26,992

You calculated the EMI for the above particulars using the IDFC FIRST Bank EMI calculator. Let’s assume that the loan has been repaid for 10 years and there are still another 10 years to repay it. After 10 years, your loan details are:

• The outstanding balance is Rs 21,30,777
• The revised home loan interest rate is 9.25%
• Tenure is 10 years (120 months)
• EMI is Rs 27,513

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 an 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 from 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 and you can continue the status quo.

Using the prepayment option
 

A home loan in India includes the option of prepaying either partially or fully after a while. Prepayment penalty is usually imposed by the lender 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 since you do not want to pay too much interest. A cost-benefit analysis is the best way for you to decide whether to prepay or not. Based on the parameters of the earlier example, the analysis would be as follows:

• Let’s assume you have surplus funds of Rs. 3, 30,777 and you want to prepay this amount without 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.

Although these savings seem great on the surface, it's important to do a cost-benefit analysis before prepaying.

Not using the part-prepayment option
 

If you decide not to prepay but instead invest your surplus funds in an FD with IDFC FIRST Bank at an interest rate of 7% for 10 years, you will earn Rs 4, 17,230 as interest at the end of that period. As mutual funds historically outperform fixed interest securities, if you are a wise investor and trust them, you can earn much more than this.

Another option that you could consider is to transfer your home loan to another lender. This entails a number of issues, including having to go through the entire home loan process again, incurring processing charges from the new lender, prepayment charges from the old lender, and reclaiming any tax benefits that may have been owed on the old loan.

Alternatively, if the RBI decreases the interest rate, you can look forward to improved home loan parameters and increased savings!

On the basis of the above analysis, you could decide how you would react to an interest rate hike on your home loan in India. 

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.