Rashi and her husband got quite a shock when they realised the principal on their home loan was no longer reducing at the same pace. The loan from a housing finance company had become more expensive, with the interest rate rising from 6.9% to 9.25% per annum, and the tenure had also increased.
The young couple had taken the loan during the Covid-19 pandemic for an under-construction property, when the lender was offering a lucrative 6.9%. The loan started in February 2021. In March 2023, just two years later, they found out the cost had gone up significantly without any prior intimation by the lender.
They felt cheated at being kept in the dark. Then, transferring the loan to the private bank where she was working cost them another round of fees and stamp duty. The process was not simple either. It involved multiple interactions, including an entire day of just sitting in the lender’s office to get the documents signed for the transfer.
Why did their home loan interest go up 2.35 percentage points?
Between May 2022 and February 2023, RBI increased the repo rate by 2.5 percentage points from 4% to 6.5% — this led to a direct cost increase for long term borrowers like Rashi.
{{/usCountry}}Between May 2022 and February 2023, RBI increased the repo rate by 2.5 percentage points from 4% to 6.5% — this led to a direct cost increase for long term borrowers like Rashi.
{{/usCountry}}Housing loans as on August end stand at ₹34 lakh crore, 47% of banks’ retail loan book (RBI sector wise credit data). Non-banking finance companies (NBFCs) have an existing outstanding of another ₹8.6 lakh crore worth of housing loans. If your home loan is part of this count, it’s likely that after last week’s repo rate hike, the interest rate on your existing home loan or the one you were planning to take will rise soon. MPC also changed its stance to calibrated tightening, which rules out rate cuts for now.
Repo or repurchase rate is the interest rate at which RBI lends short term money to commercial banks. A repo rate hike hits home-loan borrowers hardest. The interest rate doesn’t rise any more than others, but a home loan is on floating rate with built-in rate resets, it’s large and for a long period, so even a 25-basis point (each point equal to one percentage point) increase can hurt new borrowers, albeit not immediately. If tenure is increased, it could be an additional year of EMIs for existing borrowers.
According to Adhil Shetty, CEO, BankBazaar, “For borrowers with floating rate home loans linked to an external benchmark such as repo rate, transmission may not be immediate. The loan rate is reset as per lender specified reset cycle, for external benchmark linked loans that’s at least once every three months. Older loans linked to MCLR or other benchmarks may follow different reset cycles. For existing borrowers, a rate hike can mean a higher EMI or a longer tenure or both.”
But you don’t have any control on what RBI will do with interest rates. It helps to check your reset date and understand how the lender will adjust EMI or tenure beforehand.
Buying your own home can be an emotionally uplifting decision. At the same time, it is a large financial decision and taking a loan adds additional cost. Even though a loan allows you to fulfil this dream, it’s worth considering the impact on cash flows and on your future financial health beforehand.
Consider the home loan within your existing liability set: do you have other loans on which monthly repayments are going out? Would you be okay to alter your lifestyle — childcare, education, travel retirement contributions etc — if cash flows come under stress from an added monthly outflow? There is also an immediate cash outflow as a down payment. “Borrowers need to account for processing fees, legal and technical charges, stamp duty and registration costs and other mortgage related charges. These vary by lender, state and property value. So, for a ₹50 lakh loan on property that costs ₹65 lakh, a 0.5%processing fee works out to ₹25,000, stamp duty plus registration at 6% adds ₹3.9 lakh. Actual charges may vary,” says Shetty. Plus, you’ll spend on doing up the interiors and that cost will add up too.
Lastly, it’s worth checking your total interest cost across the loan tenure. Sample this: at 8% per annum interest for a 20-year loan, you will likely pay a total interest cost slightly higher than the value of your loan. If it’s a 30-year loan, your total interest cost is 1.6 times your principal. The longer your tenure, the higher the cost. There is always the risk of even higher interest if benchmark rates rise during your loan tenure.
Add the loan tenure to your age, if the result is past 60-65 years and the monthly repayment sets you back more than 40% on your monthly income, a strain on current and future financial health is likely to show up.
The advertised rate by a bank or an NBFC is usually the one which comes with the best terms and linked to the highest credit score. Don’t base your loan calculations on that rate. Check with the bank or NBFC for the rate they will offer you based on your credit score and history. Anything between a 750-900 can get you lower interest rates and better terms. At a credit score of say 600-699, interest rates offered may be slightly higher and you may not get access to the premium lenders. So, your credit behaviour matters (see this story hindustantimes.com/business/your-credit-score-just-got-more-immediate-101787736552643.html).
If needed you can take a few months to manage your existing loans and cash flows such that you are able to increase your credit score and get better terms.
Review your loan cost once a year or once in two years to ensure that you are not missing out on more attractive interest rates. Rashi had to do it under duress, but ultimately instead of the high 9.25% per annum cost on her home loan, her interest now is 7.35% per annum – which is a significant relief. It’s possible your credit score improved in the interim and another lender is willing to offer you better terms or that interest rates went down and you never repriced your loan. Being proactive helps.
“Repricing large sized loans makes sense especially if the remaining tenure is long. But also remember that there may be additional costs involved in the transfer of the loan. Do not forget to calculate that impact beforehand,” says Deepali Sen, managing partner, Srujan Financial Services.
Consider pre-paying your loan whenever possible. There can be a significant saving if you are able to build in a good pre-payment discipline (see Table 3)
Lastly, hedge for the worst-case situation — which is your untimely death. A term life policy bought online for an amount equal to the outstanding loan covers the risk. At the least, it will continue to cover your family after the loan is prepaid. The true cost of an unaffordable or tedious home loan experience shows up in sleepless nights, strained relationships and the loss of freedom to change jobs or lead a lifestyle of your choice. Borrow less than the bank will lend you. Make a down payment that doesn’t dent your goals, and choose an EMI that doesn’t cost you sleep.
Lisa Pallavi Barbora is a freelance writer and author of Money & Her