Tips for home loan borrowers

The recent hike in the cash reserve ratio (CRR) and repo rate announced by the Reserve Bank of India (RBI) has prompted banks to review their lending rates. Banks (private as well as PSU banks) have increased lending rates across the board for all loans as their input costs have gone up. Existing borrowers in all consumer loan segments, including home loans, have to pay an additional Rs 20 to Rs 30 per lakh per month in their equated monthly installment (EMI) payments.

The higher interest rate affects the home loan borrowers more than any other consumer loan borrowers because the principal amount is high and repayment tenure is longer in home loans. Home loan EMIs account for a large portion of a borrower's income that is paid out to clear the debt. Currently, home loan interest rates are quoting above 10 per cent per annum, which used to be around seven per cent a couple of years ago.

The macroeconomic situation in the country is not very encouraging at the moment. Inflation is ruling at around the 12 per cent level which is much higher than the RBI and government's mandated level of five per cent per annum.

The RBI has increased the interest rate to control the rising inflation. Analysts believe that if this era of higher inflation/interest rates continues for a long time, it will have a negative impact on the economy's growth rate. Here are some significant factors that influence the movement of interest rates.

Borrowers can expect some softening in the interest rates if some of them are moderated in the short to medium term:

This is one of the prime factors that influences the monetary policy of the RBI and forced it to hike interest rates. Currently, inflation is ruling at around 12 per cent per annum. The main factors that are driving high inflation in the country are sharp rise in prices of basic commodities like cement, steel, food items etc coupled with a hike in petroleum products (petrol, diesel and cooking gas).

These higher prices can be attributed partially to certain global factors and part of it can be attributed to issues in the local markets like speculation etc. The Government and RBI are taking measures to moderate the price hike through the monetary policy as well as government policies.

The liquidity in the system is another parameter which influences the interest rates. Liquidity influences the cost of acquisition of funds for banks. If the liquidity is low, cost of raising the funds will increase, and hence they will need to raise the interest rates on their lending. There are many factors that influence liquidity in the system.

For example, fund inflows from foreign investors and a cut in the cash reserve ratio increase the liquidity in the system and vice versa. Currently, many foreign investors are taking out their funds from the domestic markets due to issues in their local markets as well as growth concerns in emerging markets.

Rates expected to drop
Existing home loan borrowers need not panic at the high interest rate scenario ruling today. Experts believe that the rates are near their peaks and expect them to moderate in the near to medium terms. Most of the banks offer various options for the existing borrowers such as extending the tenure of the loans (rather than increasing EMI) or prepayment of a part of the loan in order to keep the EMI outgo constant.

New borrowers should be a little cautious and evaluate their financial positions before opting between the fixed and floating interest rate options. They can also evaluate combo/structured products like part fixed and part floating interest rates, and step-up EMIs which are low in the initial stages but increase in later years. Borrowers should also weigh the options of making a part prepayment or switching to fixed/ floating interest rates.

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