What to watch out for in your loans

What to watch out for in your loans

With interest rates rising across the board in the financial system, borrowers will have to shell out higher equated monthly instalments (EMIs) for loans taken to buy homes, vehicles and other consumer durables. As a result, they may have to rework their strategies to keep finances under control.

What’s the hike so far?

The RBI had cut interest rates from 5.15 per cent in February 2020, when Covid-19 hit, to as low as 4 per cent by May 2020. Interest rates on home loans had fallen to as much as 6.50 per cent from around 10 per cent, prompting buyers to go for loans. Since May this year, interest rates are back on an upward climb, with Repo rates rising by 190 basis points to 5.90 per cent as the RBI fights to bring down inflation. The hike in Repo rates means the cost of funds of banks and housing finance companies is also rising, leading to the transmission of the hike to customers.

Sales of residential units have increased by more than two times during the first half of 2022 vis-à-vis the same period last year, and the growth trajectory was maintained during the July-September quarter. With the last week’s repo rate hike, home loan EMIs would increase by an average of 8-9 per cent from six months ago. Ditto is the case with vehicle loans and other personal loans.

The continuous rise in home loan EMI is hence, expected to act as a sentiment disruptor. “We believe that home loan interest rates inching towards 9 per cent and above may result in moderation of housing sales growth in the medium term, especially post the current festive season,” said Samantak Das, Chief Economist and Head of research and REIS, JLL India.

Will rates go up further?

The RBI raised the Repo rate by 50 basis points to 5.90 in the last monetary policy review as the Monetary Policy Committee (MPC) seeks to ensure that inflation remains within the target, while supporting growth. The regime of high-interest rates is expected to last for two to three years or till when the inflation level comes down and the central bank cuts down the Repo rate.

While the central bank retained its CPI inflation projection at 6.7 per cent for FY23, it downgraded the real GDP growth projections for FY23 to 7 per cent from 7.2 per cent and FY24 at 6.5 per cent. CPI is likely to remain above 6 per cent for the first three-quarters of FY23.

“Elevated imported inflation pressures remain an upside risk for the future trajectory of inflation, amplified by the continuing appreciation of the US dollar. We believe that a 35 bps rate hike in December looks imminent but beyond December it would be touch and go,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.

This indicates that EMIs or tenure on loans can rise further.

How is the rate hike impacting your loan and savings?

Home loan rates have risen by nearly 200 basis points over the last five months. The higher EMI and longer loan tenures along with inflation have meant that there is an increase in expenditure and a reduction in savings for individuals.

As the RBI has raised the repo rates by 190 basis points, many home loan customers have witnessed banks and housing finance companies raising their rates by around 190 basis points. The impact: If the interest rate on a Rs 50 lakh loan outstanding for the remaining tenure of 15 years (180 months) has gone up by 190 basis points from 7 per cent to 8.9 per cent, the tenure of the loan would rise to 236 months (if the EMI is kept constant). However, if someone wants to keep the tenure constant or is not able to increase tenure because of age limitation or any other factor, then the EMI would jump from Rs 44,941 to Rs 50,416, a monthly increase of Rs 5,474.

What can one do?

Here are a few things that one can do to keep the financial impact under control.

Do assess your loan: The most common mistake that individuals make is that they ignore assessing their loan schedule — if the bank/HFC has not raised the EMI but only increased the tenure. While individuals keep reading that the rates have risen and banks and HFCs have revised their rates, there are very few who make the effort to check how much their loan tenure has increased. It is important to monitor the loan in order to be able to address the issue.

Can break fixed deposit and partially pay your loan: It is important to assess investments. If you have a fixed deposit that is earning 5 to 6 per cent, the post-tax return on it is limited to 3.4 per cent to 4.1 per cent (for an individual in the highest tax bracket). Individuals can use a part of that fixed deposit to pre-pay some of the loan and keep their tenure and EMI under check. There is no point earning 4 per cent from a saving instrument if there is an ongoing loan on which one is paying around 9 per cent.

Increase your EMI partly: If the increase in tenure is making you anxious, go for a partial increase in EMI. So in the above example, as the rise in interest rates leads to an increase in tenure from 180 months to 236 months, if the individual requests his bank/HFC to raise the EMI by Rs 2,500 to Rs 47,441, the tenure would come down to 206 months. For those who can afford it, it makes sense to increase the EMI and limit the impact of interest volatility on their loan schedule.

Big jump in personal loans

Personal loans of banks jumped by 19.5 per cent to Rs 36.47 lakh crore by August 2022 from Rs 30.51 lakh crore a year ago. Home loans, the biggest component of personal loans, rose by 16.4 per cent to Rs 17.85 lakh crore from Rs 15.34 lakh crore as borrowers took advantage of the low-interest rate regime. Credit card outstanding also jumped by 27.3 per cent to Rs 1.67 lakh crore from Rs 1.31 lakh crore.

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