In the last 15 months, the Reserve Bank of India (RBI) has hiked policy rates by 300 basis points. (100 basis points is 1 percentage point). Lending rates have followed suit and have risen by almost 3 percentage points. For you, this has translated into a steadily increasing equated monthly instalment (EMI) burden. Since the home loan is likely to be the biggest liability you have taken, the quantum of EMI hike would be the biggest, too, and may pinch you the hardest. To accommodate that extra bit, you would have altered your finances and savings pattern. But with another round of rate hike on the cards, you may need to take a closer look at your finances.
While cutting corners is the first step, remember that every case is different and the strategy to handle the increase in EMIs varies too. You could pay the increased EMI or increase the tenor. Switch the loan to another lender or ask the lender to restructure the loan. Dilute investments to make part payments to reduce the EMI burden or ask the lender to defer the EMIs by a few months. Ensure that your choice suits your specific situation.
We spoke to two loan borrowers to find out how they are coping up and what they plan to do if there are further rate hikes. We also spoke to certified financial planners to find out whether they are on the right track. This exercise aims at giving you a direction on the basis of the specific situations and the planners’ take.
ABHAY MORE, 39
Then (2004): 7.3% (interest rate), Rs 9,177 (EMI),
Now: 10.5%, Rs 12,500
Planner's solution: Instead of saving in a recurring deposit, More can increase his EMI amount. With the same EMI, he should choose an investment vehicle that gives a hugher return.
Abhay More is a typical sandwich generation case with growing kids and an aging parent to look after. He bought his Pune flat, where he lives with his family, in 2004 on a loan from a foreign bank at an interest rate of 7.3% and a tenor of 15 years. After several rate hikes and two loan switches later, his interest rate is 10.5% and total loan tenor 19 years.
He's been able to manage his loan so far. "My wife, Snehlata, also works and the double income helps," said More.
His savings: More has been regularly setting aside savings for years now. Increase in the EMIs won't hurt him much, but it will definitely eat into his savings. At present, the More couple is able to save around Rs 8,000-9,000 a month. He also has some investments in physical gold and silver and a systematic investment plan (SIP) of Rs 2000 a month. He saves Rs 2,000 per month in a recurring deposit (RD) to part-prepay the loan at the end of every year. This, he thinks, will reduce his EMIs.
The right strategy: But Suresh Sadagopan, a financial planner, doesn't think opening an RD makes sense. "If possible, he should increase his EMI by Rs 2,000 every month. He is paying a loan at an interest that is higher than what he would be getting in an RD."
But what if he prefers prepaying the loan and not increasing the EMI? Then he should look for some other investment instrument, Sadagopan says.
For someone who is financial cautious like More, who chose to buy a second-hand car, increasing the tenor of the loan or switching the loan is no longer an option. "There is no point in switching the loan to another lender since interest rates should start correcting in around six months," said Sadagopan. "If More wants to accumulate funds to prepay, he could look at quarterly interval funds, which will give a return of 7%-plus, till February-March. After that, a fixed maturity plan that matures in April 2013 can be considered."
Shweta Naik, 30
Nitin Amin, 30
Then (2010): 9.0%, Rs 41,349
Now: 10.8%, Rs 46,732
Planner's solution: Don't increase the tenor of loan even if EMI increases, but ensure EMI doesn't cross 40% of monthly salary.
Shweta Naik and Nitin Amin fell in love when they were in school and got married in 2009. They bought a house soon after in 2010. While Naik works with a fund house and pores endlessly over books, Amin is the creative one and works as an animation artist.
When they took the loan for a tenor of 20 years, it cost them 9.0%, they are now paying 10.8%, translating to an increase of about Rs 5,000 in their EMI.
Their savings: "I wanted to start investing Rs 5000 in mutual funds (MFs), but now I pay an increased EMI. So my plans to increase investments in MFs and buying insurance have been hit," said Naik. As of now, they have a few SIPs and manage to save around R8,000 per month.
But to maintain their savings rate, they have cut down on lifestyle expenses, such as spending on theatres. The couple had decided to buy a car, but will now settle for a bike to cut costs. "A car would mean another EMI burden of at least Rs 6,000," said Amin.
But they fear another increase in rates may rock the boat. "I am expecting a letter from the bank and this time, the interest rate may go up to 11.3%, which means our new EMI could easily go up by another Rs 2,000-3,000."
The right strategy: Mumbai-based financial planner Pankaj Mathpal has a simple solution for them.
"If interest rates increase, I recommend them to check their cash flow and increase their EMI if they can afford it instead of increasing the tenor," said Mathpal. "But they must see their comfort level. They should ensure that their total loan EMI does not exceed 40% of their monthly income."