Prepay home loan to tackle 190-bps rise in repo rate since May: Experts

If you don't have a surplus, opt for higher EMI rather than longer tenor

Home loan borrowers will have to bear the brunt of Friday’s 50-basis-point hike in the repo rate by the Reserve Bank of India. The benchmark rate, which now stands at 5.9 per cent, has risen by 190 basis points altogether in the current rate hike cycle.   

Tenor to increase

Suppose that a borrower took a home loan that now has a principal outstanding of Rs 50 lakh and remaining tenor of 20 years. The starting interest rate was 7 per cent. With the rate rising to 8.9 per cent, the tenor could, in theory, rise to 424 months, assuming the EMI remains constant. “At 424 months, the tenure of this loan increases by 184 months or more than 15 years over the original,” says Adhil Shetty, chief executive officer (CEO), Bankbazaar.com.

Prepay loan   

Borrowers who have surpluses should pre-pay their loans. “Borrowers should prioritise pre-payments to control their interest cost. This will help them reduce their loan tenor and EMI,” says Shetty.

Opt for higher EMI

When home loan rates are reset, the lender usually hikes the tenor while keeping the EMI cost. After the 190-basis-point increase in the current rate cycle, however, many borrowers, especially the older ones with large principal outstanding, may find that their EMIs have been hiked.

Increase in EMI is better than an increase in tenor. “The total interest cost incurred will be lower if a borrower goes for the EMI increase option rather than the tenor increase option,” says Gaurav Aggarwal, senior director, Paisabazaar.

Home-saver loans   

Under this facility, an overdraft account is opened in the form of a savings or current account. The borrower can park his surpluses into this account or withdraw from it, depending on his financial requirements. “The interest on the home loan is calculated after deducting the surplus parked in the savings or current account from the outstanding home loan amount. This facility allows home loan borrowers to derive the benefit of making prepayments without sacrificing liquidity,” says Aggarwal.

Existing home loan borrowers who have witnessed a substantial improvement in their credit profile after taking their home loan can opt for home loan balance transfer to reduce their interest cost. Their improved credit profile may make them eligible for availing home loans from another lender at a lower interest rate.

“Irrespective of the interest-rate scenario, borrowers must periodically examine the option of switching to the best possible interest rate they can get for their credit profile,” says Aditya Mishra, director–home loan desk, 4B Networks.

With pre-payments becoming crucial in the current scenario, go for a lender whose terms for prepayment of loan are not stringent.

Ladder your FDs

After Friday’s rate hike, banks are also likely to hike fixed deposit (FD rates), albeit with a lag. “With credit growth rate at a high of 16.2 per cent year-on-year, banks may be quicker in raising FD rates now,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Experts say we are close to the peak of this credit cycle. “Instead of trying to predict the peak, investors should ladder their investments in FDs,” says Dhawan. Doing so will help average out the returns from FDs.

After factoring in taxation and inflation, returns on FDs rates are not very attractive, especially for those in higher tax brackets. Highly conservative investors, senior citizens, and those in lower or zero tax bracket may allocate more to FDs. Others should only keep money needed in two-three years in FDs. If your investment horizon is five years, opt for balanced funds, and if it is seven years or more, invest in equity funds.