Loans have become more expensive by 90 basis points since May 4 and there could be more hikes in the anvil
Home loan rate at 6.5 per cent until April was something unheard of. But the rates fell so low because the Reserve Bank of India adopted a new mechanism to transmit the rate movement in September 2019. Called the external benchmark linked rates or EBLR, it was aimed at ensuring that every change in the base rate or the repo reflected almost immediately on the lending rates of banks. Consequently, most home loans are benchmarked to repo and hence, when the base rate fell to four per cent in 2020, it benefited borrowers. Now, that trend of low rates is reversing. Repo has risen by 90 basis points (bps) since May 4. The cheapest home loans are available at 7.3 per cent as against 6.4 per cent just a few months ago.
In the current fiscal, expect few more rounds of rate hikes, perhaps another 75 bps going by the consensus. That means by March 2023, repo could increase to 5.65 per cent. Assuming a direct pass through by banks, the cheapest home loan could increase to 8.15 per cent. If you recall, home loan rates were around the eight per cent mark in 2019. As a borrower, here are a few things you should know to navigate the hikes.
Who’s most affected
Over 80 per cent of retail loans are on floating rate and hence a rate hike will impact all categories of loans. But within this, given that EBLR, when introduced, was primarily targetted at home loans as this segment accounts for over half of retail loans, the transmission or price pass-through, so far, has been the highest and very rapid with home loans. Car loans, two-wheeler loans, personal loans and the credit facility on credit cards are also turning expensive. But the quantum of rate hikes in these products isn’t uniform, the reason being less than 40 per cent of these loans are benchmarked to EBLR. Banks still adopt MCLR or marginal cost of borrowing based lending rate for these products, which, by default gives a broader bandwidth to fix the interest rates.
While MCLR is also benchmarked against the repo rate, there are more layers of pricing components compared to EBLR. Therefore, while home loan rates have increased by 90 bps since May 4, banks are taking discretionary hikes on other products. For instance, while Axis Bank has increased car loan rates from 7.45 per cent in January to 8.5 per cent now – almost 100 bps, for SBI, the rates have moved from 7.2 per cent to 7.7 per cent.
Impact on EMIs
If you have been looking to buy a house and the loan component would work out to ₹75 lakh payable over 20 years, had you locked in the deal in April at 6.5 per cent, the EMI burden would have been ₹55,918. Now that increases to ₹59,506, assuming a rate of interest at 7.3 per cent. But this is if your credit score is over 791 and you are a super-prime customer. For a prime or near-prime borrower with credit scores between 681 and 790, interest rate can go as high as 7.65–7.9 per cent. That translates to an EMI burden of ₹61,109 and ₹62,267 respectively. On an annual basis, it’s an incremental outflow of ₹46,000 to ₹73,000 depending on the credit rating.
For existing home-loan customers, the arithmetic can work out a little different. Instead of the EMIs increasing, banks, by default, extend the tenure of the loan. If it’s a 20-year home loan, the tenure can extend increase by 10 months for every 25 bps increase in interest rate. This is going by the thumb rule. If you had availed a home loan for 20 years at 6.5 per cent, post the 90 bps interest rate increase, the tenure elongates by three years. Factoring an additional 75 bps hike expected this fiscal should be factored, we are talking about the home loan duration increasing from 20 years to 25.5 years, assuming you want the EMI unchanged.
Your options now
The good news is that even if another 75 bps of rate hike should be factored in, we would still be at borrowing rates lower than 2018 when average home loan rates were at 8.75 per cent . Hence, all is not lost. But given that we are in an increasing rate cycle now, if you want to keep the borrowing under check, you could make a higher down payment, provided your financial position is comfortable otherwise.
Points to note
Despite the rate hikes, we would still be lower than 2018 levels
For existing borrowers, loan tenure may increase rather than the EMI burden
Don’t rush to repay the loan or look for fixed rates
Prepaying some portion of the loan to reduce the interest burden or avoid extension of tenure can be an option that crosses your mind. But if you are at the early periods of loan tenure, there could be more rate hikes through the loan period and hence prepayment now may not solve the issue once and for all. However, if you are closer to the end of the loan tenure, and there is enough savings for emergencies, foreclosing the loan instead of shelling out expensive EMIs or extending tenure may be a good option. That said, prepayment or foreclosure decisions also involve several other variables such as assessment of tax benefits lost, opportunity lost on using your surplus cash towards the loan rather than investing it and earning returns, etc. Thus, the decision must be well thought out.
Another thought that may come up is, whether you can avoid these shocks by opting for fixed rate loans. For home loans, fixed interest rates start at 9.6 per cent. Private banks’ fixed rates are steeper at over 11.5 per cent. That’s still 220 – 410 bps higher than floating rates. For all you know, you may end up paying more. Floating rates makes sense across product categories, especially if you are a prime or super prime customer.