LoanRaja Blog- Personal Finance Guide

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.

Earlier a status symbol and now an integral possession of every wage earner and self-employed person in urban areas, the ubiquitous credit card is a pointer to the rising consumer spending in India. Aggressive campaigns by banks and NBFCs over the years to cash in on the burgeoning middle class consumers’ itch for ‘buy now pay later’ led to a phenomenal rise in the penetration of the plastic money. Foremost advantage of a credit card is its mobility. For shoppers and travellers, choice of a credit card is a matter of convenience. The cards have increased the purchasing power of the individuals and the younger generation is on a shopping spree.

Basically credit card operations rely on four players. Visa, Master, Diners, American Express and JCB are the providers. The second group comprises of vendors or the respective banks and financial institutions, which issue cards on behalf of the providers, like ICICI, HSBC, Citi bank, SBI, HDFC, Standard Chartered etc. Then come the cardholders. Lastly there are shop owners or any other establishments that accept the cards from the holders and honour the purchases made by them or the service rendered to them. Many cards have special features like accident insurance cover to make it attractive. Good customers get rewards too.

Strict terms

It is easy to get a credit card if you can provide the bank /NBFC proof of identity, address and income. Before taking the plunge compare the terms offered by different banks and make a wise choice. Watch out for any hidden charges. Ignorance of some of the charges levied can prove costly later. Terms, which used to be stringent, have been liberalized. Along with attractive offers to lure customers towards their credit card banks also set some strict conditions for non-repayment, penal interest and late payment charges. All bank websites display the dos and don’ts of credit card use. These are also given on the reverse side of statements. Besides customers get email alerts also.

A credit card customer normally enjoys a free credit of 50 days and the shopkeeper gets his payment from his banker as soon as he presents the statement of the purchases made. The bank then sends the vouchers to their respective head offices or clearing offices where the money is collected from banks that have issued the cards. The whole operation takes about three weeks whereas the credit enjoyed by the customer is much more than that. Credit-free period is the time given by a bank to a customer to make payments on credit card purchases without having to pay any interest. If wisely used, credit card can be a source of interest-free working capital for a self-employed person.

Cash withdrawals

If you have an urgent need for cash you can swipe the card to draw cash. You have to consider this as the last resort since this facility is accompanied by some harsh terms. Every time you draw cash you have to pay a minimum service charge of Rs.500. The interest also is higher. Repayment of cash withdrawal also is a complicated process and you can fall into a debt trap. Credit card is short-term credit, which is costlier than a personal loan. Banks charge high interest rates of over 36% per annum on credit card debt, as it is unsecured. Delinquency rates are high. In default cases there is a high degree of write-offs.

Before selecting a credit card the customer must be clear about all fees a bank is charging. Compare the rates of different banks first. Credit cards have different types of fees like joining fee, annual fee, renewal fee, add on fee, card replace fee etc. Prompt payments can avert problems. If you pay only the minimum balance you may have to pay interest on next month’s bill also. RBI has clear guidelines to make credit card operations transparent. The terms and conditions on credit card must be clearly conveyed to the customer and banks are barred from collecting any fee other than what was mentioned at the time of issue of the card. There are ample avenues for grievance redressal.

Choosing the right tenure for your home loan is as important as choosing the interest rate. In the backdrop of recent interest rate hike propelled by galloping inflation choice of a favourable home loan tenure becomes al the more important. You have to consider several factors when you decide to take a home loan for a specific period. Age is a major factor. The younger you are, the higher is the tenure available for your home loan. If one decides to take a loan in his 30s, he can get a loan for 20 years — the maximum loan tenure offered by most Indian banks. For older people the choice is limited, as banks don’t stretch loan tenure beyond retirement age.

Go For The Right EMI

Striking the right balance between the loan tenure and EMI, a fixed payment made by a borrower to the lender every month, is crucial. EMI has an unequal component of principal and interest so that over a specified number of years, the loan is paid off in full. Initially, a major part of the EMI goes in paying the interest only. The interest component could be as high as 80 per cent of the EMI. Later, the principal component of the loan increases. The value of the EMI depends upon the loan amount, interest rate and the duration in which the loan is to be repaid.

It is not advisable to take the shortest possible tenure. You may end up with a heavy EMI that may overstretch your resources. Even when you are repaying the loan, you must save. EMI must not pose too much of a financial burden. A borrower has to calculate the EMIs for various terms. Decide on the tenure with an EMI that you are comfortable with. You should find out whether you can meet all your monthly expenses and also make some saving after paying the EMI. If so, you can settle for an EMI around this figure. Pre-pay if possible. While doing so look out for any penalty clause for prepayment in the loan agreement. There is no penalty for part-prepayment. If interest rates fall later then you will benefit by part-payment. When interest rates are on an upswing prolonging the loan period is not prudent.

Tax Benefits on Home Loans

Higher EMI may be a better option if you can afford it. You may also be able to get tax rebates on your increased interest outgo. The amount paid towards the principal, up to Rs 20,000 per year could be treated as investment under section 88 of Income Tax Act. The amount paid towards interest, up to Rs 1.5 lakh per annum, is deducted from the Total Income U/s 24, of Income Tax Act. When you are taking a home loan, check out the EMI and take the right decision. Normally, the EMI stays constant through the period of the loan. If you opt for a prepayment of part of your loan, you will be paying lower EMIs’ for the remaining period of the loan tenure or pay the same amount and finish payments sooner.

A loan-seeker has to check whether interest is being calculated on daily, monthly or annual rest. You pay more as interest over the years in case of annual rests compared to monthly rests, even if the interest rate is the same. When the interest rates go up the financial institutions either raise the EMI amount or extend the tenure of the loan. Some HFCs ask the borrowers to pay the differential interest at the end of every financial year.