If you are an individual waiting on the sidelines for good news on the interest rate front, this article is apt for you. The good news has been pouring in on the interest rate front with repeated cuts in repo rate and cash reserve ratio. If you are wondering how this is going to affect you, below is the answer.
Now that the inflation has slipped to a manageable level, the government and RBI are keen on reversing some of their earlier moves. In addition, the existing financial crisis across the globe coupled with tight monetary policy has affected the growth of the economy as companies are devoid of funds. In the coming days, the picture could change for the better.
Hence, for those looking to avail loans, life is likely to get a lot better. To start with, home loans and personal loans are likely to get cheaper by at least 0.25-0.5%. Over a period of 6-9 months, there could be another round of fall and we may go back to the days of home loans of 10-11%. As you are aware, the rates in recent times had touched 13% level in the last couple of quarters and increased the EMI by a few thousand rupees for many. In fact, the rising interest had forced many to abandon floating rate option. Now that the noise for softer interest rate regime is getting louder, you can go back to the option of floating rate.
While banks are still not rushing to announce their new lower rates, the trend is likely to get more visible in the coming months. As of now, the fresh rates are applicable only for fresh loans and it may take a while for existing borrowers to enjoy the cut in interest rates. While car and personal loans are least affected as their rates are fixed (at the time of borrowing), the fall in interest rate is good news for home loan borrowers. And the good news is that government, with general elections round the corner, is in no mood to antagonise the voting population. That is one of the reasons why the Union Finance Minister, P Chidambaram, has taken it upon himself to induce banks to lower the rate cut. If you are a borrower or looking for a loan, you are sure to love the FM!
Low home loan interest rates which had contributed to the real estate boom during the past few years are now spiraling upwards upsetting the calculations of borrowers. Higher interest rate means a higher monthly payment to the financial institution or an extended tenure for repayment. Coupled with escalating price of properties due to higher input costs the rate hike has compounded the woes of a homebuyer. The recent RBI steps like hike in CRR and repo rates to bridle inflation have forced banks to raise interest rates on home loans.
Some banks have already asked borrowers to pay the differential interest as a single sum by the end of the financial year. Others have increased the loan tenure. When the housing loan rates were 7 to 8.5 per cent banks vied with one another to slash it down further to woo customers. Interest rate that remained as low as 7 percent five years ago has more than doubled now. Some banks have only raised their floating rates. Some have increased the processing fees on all loans. It is a tricky situation for borrowers.
Impact on EMI
For a .5 per cent hike in the home loan rates, the borrower will have to shell out anywhere between Rs 25 and Rs 35 per month extra on every Rs 1 lakh borrowed. The EMI is calculated based on the interest rate, loan amount and term. On a home loan, the EMI for a Rs. 20 lakh loan at 13 per cent for 20 years is Rs 23,432. If interest rate goes up by 1 percent EMI is Rs. 24,871. Additional monthly burden is Rs.1439 and yearly outgo Rs.17,268 more. EMI has two parts — the principal and interest. The money that goes into the interest component will be higher. When interest rates rise the interest component of the EMI too increases and the principal repayment component comes down. Borrowers who have opted for floating rate are the worst sufferers during interest rate hike.
How can borrowers beat the inflation? It is always better to pre-pay the housing loan if extra cash is available with you. A customer can liquidate fixed deposits if any to prepay the loan, as the yield will be lower than the interest on home loan. Before opting for prepayment a customer has to ascertain whether the loan agreement has any clause on pre-closure penalty. Charges vary from 2 to 3 per cent. Another disadvantage is that the income tax benefit available for repayment of interest up to 1.5 lakh per annum won’t apply in the case of foreclosure. SBI is one of the banks that charges no penalty if the loan is pre-closed from own savings or windfall gains.
Part-prepayment
Another option is part pre-payment to help reduce the loan tenure and interest rates. This can lower the EMI and thereby limit the interest cost. The problem of penalty on pre-closure of home loan can be got over by resorting to partial payment of principal amount as no bank levies penalty on part-prepayment. It is tempting to migrate from floating rate to fixed rate. But this also will invite a charge. Besides, genuinely fixed home loans for long term are not available now.
The decision to go in for a home loan has to be taken with utmost care and planning. Since it has long-term implications on the family budget thorough planning is a must. A false step can land the borrower in unexpected financial strait. Plethora of schemes and incentives being advertised by lenders regularly can confound any prospective borrower. The market is crowded by hordes of sales agents who tend to paint exaggerated figures on eligibility and interest rates.
Never blindly go by the advertisements that promise loans at very cheap rates or the sales agents’ words. He may give a false impression about your eligibility and try to persuade you to borrow more than your requirement. The first step is to make a realistic assessment on the resources you can spare every month for repayment of the loan. Then try to find out your eligibility. Not all banks calculate eligibility norms alike. Some go by the net salary while others go by gross salary. Some HFCs take into account the income of close relatives of the borrower while others include only the spouse’s income. Gullible borrowers may blindly opt for loans on the basis of false assumptions and end up taking more than they can afford.
Explore your options
Many borrowers just go to a single HFC and accept the deal they are offered there without making enquiries elsewhere. In a competitive market there is always room for a better bargain. All rates including processing charges are negotiable. Get a thorough understanding of interest rates and service charges prevailing in different banks. Try to get in writing from the lender the prevailing interest rates and other fees. Better to opt for the bank that offers the lowest EMI. Hiding details about your liabilities and assets may have disastrous consequences, as the lender will invariably scrutinize them closely. If you can prove to the lender that you have a good track record in repaying loans it will be advantageous. If you can get a pre-approval letter from the bank it will help you to negotiate better with other lenders.
Customarily, a loan agreement is weighted in favour of the lender. Some financial institutions may have hidden clauses and conditions, which may not be conveyed to the prospective borrower initially. But all these unfavourable clauses will surface in the final agreement, which may be different from what was promised. Some borrowers tend to sign on the dotted line. Never sign a loan agreement without thoroughly understanding the implications of all clauses like foreclosure charges, reset etc. Lenders generally reserve the right to revise the rate of interest at their discretion. Even if you have opted for a fixed rate loan it is not really fixed. It is vital to know what action the lender will take in the event of default. Customer should know whether any penal interest would be levied. Lenders have also a right to recall the loan at any time.
Interest rates
Loan rates are not uniform. Customers usually are in a fix on choosing between fixed rates or floating rates. They often don’t have a clear idea about the exact difference between fixed rates and floating rates. The two basic types of home loans based on the interest rate are fixed rates and floating rates. Market conditions determine the floating rate. Floating rate loans are subject to periodic review, normally every quarter. Some HFCs review rates annually. Check whether the fixed rate loan you have chosen has a reset clause that allows the bank to review interest rates. In the case of floating rate it has to be ascertained whether the interest is being calculated on daily, monthly or annual rest. Consequently you end up paying more as interest over the years in case of annual rests as compared to monthly rests, even if the interest rate is the same.
