Interest Rate Management

The recent hike in the rates will hurt your finances further. Time to do some stock-taking.

Earlier this week, Reserve Bank of India (RBI) governor Y V Reddy surprised everyone with his double whammy. The apex bank increased repo rate and cash reserve ratio (CRR) by 50 basis points (bps) and 25 bps respectively.

Within days, banks revised their rates with the Punjab National Bank (PNB) revising its home loan rates by 100 bps. This was quickly followed by HDFC and ICICI Bank, who raised their rates by 75 bps, effective from August.

In the last few years, the Indian economy has been booming. An inspiring growth rate of 8-9 per cent in the gross domestic product (GDP) has ensured that salaries have increased exponentially. And the rising incomes have translated into increasing demand for goods and services.

Today, one does not see builders constructing one bedroom apartments. A person has to, hence, opt for a 2 bedroom flat at least. This means, though income has gone up, so have prices and average size of an apartment. And the rise basically means that equated monthly instalment (EMI) along with maintenance expenses can take a toll on any budget.

An advantage that consumers enjoy today, unlike a decade back, is that the government has extended tax benefits to encourage home buying. This effectively brings down the overall loan burden.

Any home buyer today gets tax exemptions on an interest payout of Rs 1.5 lakh a year. Also, the principal payment gets deduction under Section 80C up to Rs 1 lakh a year. That is, a total benefit of Rs 2.5 lakh can be claimed thereby reducing your tax liability substantially.

However, when interest rates start shooting up, consumers need to find other ways to ensure that their budgets are under control and they do not have to suffer any financial strain. Here are some proactive measures that you should take to help pass through this tough period.

• Review every loan and look at the amortisation schedule of each loan. Make sure you understand the exact interest amount that is being paid every month. Car loans, unlike home loans, are mostly fixed rate loans (some banks like ICICI Bank have recently introduced floating rates on car loans as well) and, hence, existing car loans will not be impacted by interest rate hikes. If you have already paid your car loan for around 3 to 3.5 years or most part of the loan tenure , there is no point in prepaying it further. Check the balance interest and it is bound to be negligible. In such cases, continue this loan. Same goes for any home loan. Once you have crossed 10-12 years of the loan tenure (for a 15-year loan), interest rate increases do not impact your monthly instalments greatly.
• A car purchased through a loan is not the smartest things to do now. Take into account your overall situation before going for an auto loan. If you still decide to go for one, check whether there are any investments that are not giving you good returns. Liquidate some of them. If you must take a car on a loan, make sure you negotiate with the car dealer. You are likely get a good deal as car sales are down (As it can be clearly seen from the sales data of auto companies).
• Pay off all those personal loans and credit card debt before you apply for any other loan. And after you have understood all your amortisation schedules, you can look at prepaying around 25 per cent of your home loan now or do some part prepayment to reduce the rise in tenure. Always remember that rising rates get reflected , either in the EMIs or tenures. Whereas, the former would have immediate impact, the latter would kick-in later. Alternatively, one needs to ensure that these investments, over the next few years, should comfortably beat the interest rate of your loans. If you are planning to park funds in fixed deposits, it makes more sense to pay off a loan.
• If you are thinking of buying a new house, it is strongly recommended that you review your overall financial situation carefully. This is not only about interest rates, but also home prices as well. It will make no sense to pay high interest rates and higher prices for the new house. It might make a lot of sense to rent today than to buy a house.

The price differential between a rent and EMI is likely to be substantial. Being patient for prices to come down will ensure that you will pay a lot less later (property prices are already under pressure from lack of demand). If you must buy a house, negotiate the price and do not buy one at a high price. At the same time, look for banks that offer lower interest rates and are not as aggressive in hiking rates as others (even if it means going through reams of paperwork). All these will help you in these tough times.

The writer is director, My Financial Advisor