How RBI’s Repo Rate Hike will Impact Your Home Loan EMIs

Many leading commercial banks have already hiked the home loan interest rates for both; existing and new borrowers. If you are an existing home loan borrower, the hike in home loan interest rate will give you two options; either to continue with the same monthly repayment (EMI) by switching to a loan tenure or to pay higher EMIs by keeping the same loan tenure. As the cost of the loan will impact existing as well as new borrowers, it is crucial to decide whether you should increase the EMI or loan tenure.

As per revised rules related to home loan interest rates effective from October 2019, banks are required to link their home loan interest rates to an external benchmark. Banks may choose any of the external benchmarks given below:

1. The RBI's repo rate

2. Government of India's three-month treasury bill yield published by Financial Benchmarks India Pvt. Ltd. (FBIL)

3. Government of India's six-month treasury bill yield published by FBIL

4. Any other benchmark interest rate published by FBIL

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The final interest rate that will be levied on the retail loan will be:

External benchmark rate + Margin + Risk premium

Further, banks are required to review and revise the interest rates linked to the external benchmark at least once in every three months.

An increase in the policy repo rate makes the deposits more attractive and borrowings costlier. The higher repo rate results in a higher cost of funds for the banks. This, in turn, results in banks raising the interest rates for home loans, car loans, and personal loans, which ultimately hits your pocket as your EMIs increase.

Here is an example of what your home loan EMI will look like after considering the hike in the interest rate:

Whereas, if you choose to pay the same EMI and increase the loan tenure, your loan tenure will increase by approximately one year for the same example of a loan amount of Rs 50 Lakhs.

Most banks have a default option of extending the loan tenure. It does not create an additional financial burden on borrowers' monthly repayments and makes the lenders earn higher interest. Although extending the loan tenure seems a convenient option, you should know that the higher the loan tenure, the higher the total interest outgo will be. Therefore, it makes sense to opt for increasing the EMI amount rather than extending the loan tenure. However, while increasing the home loan EMI, you should ensure that the increased amount will not hurt your family's cash flow.

Given the high and persistent nature of inflation, many experts believe that the interest rates are likely to head up for some time. Considering this, it is advisable to prepay your existing loans after analysing the part-payment and prepayment charges with your lender. Besides, if your home loan is linked to MCLR (marginal cost of funds-based lending rate), you should consider switching to the Repo Rate linked loan after careful analysis and calculation. If you are getting a good deal on a home loan balance transfer, you should consider doing it. Make sure that depending upon the loan tenure left, the difference between your existing interest rate and the new interest rate should be at least 25 to 70 basis points. Moreover, if you are planning to take a home loan, it is advisable to be prepared for higher interest rates in the future and avoid over-leveraging in these circumstances, as the home loan interest rate might seem affordable today, but it might not remain the same in the future. For new borrowers, it makes sense to choose the lender that offers easier and more flexible loan terms in terms of down payment and prepayment.

Warm Regards,
Ketki Jadhav
Content Writer