Harsh Vardhan Roongta is CEO, Apnaloan.com, the largest online market place for
home loans, credit cards and personal loans.
WAYS TO BE WISE WHENHOME LOAN RATES RISE
The monthly budgets of more than three million households have gone for a toss
due to the relentless rise in home loan interest rate over the last 24 months.
As people struggle to pay the increased EM Is, they also worry that further rise
in rates will hit their already strained budgets.
For somebody who took a Rs. 10- lakh, 20-year home loan at the bottom of the interest
rate cycle, the EMIs have gone up from Rs. 7,600- to Rs. 10,399. ( may vary according
to interest rates) In spite of the recent increases in monthly incomes, this huge
rise in EMI, coupled with high inflation rates affecting other items of daily
living, is beginning to take its toll on the monthly disposable incomes and savings.
So what options do you have to safeguard yourself against this relentless rise
in interest rate?
Should you shift to a "fixed rate" home loan?
This is not advisable as very few banks provide genuine fixed rate loans anyway.
Genuine fixed rate loans are those where the loan document does not have any clause
in the agreement that allows the bank to change the "fixed rate" of interest.
These loans are not available for less than 13.00%, plus you will need to pay
a fee for shifting to such loans. So your EMIs will go up immediately and, moreover,
you will need to pay a fee to shift to such fixed rate loans. This shift will
remain more expensive till the floating rates move beyond the current fixed rates
of 13.00%. We must not forget that interest rates move in cycles and that over
the long tenure of a typical home loan, you will be able to benefit from the drop
in rates (as and when they happen) also just like you have paid for the increase
in rates. Whilst the short-term outlook on interest rates clearly points to an
increase, an assumption that interest rates will forever remain high will be incorrect.
We have already seen one cycle of interest rate movements in this decade (downwards
from 2000 to 2004 and broadly upwards thereafter) and there is no reason to believe
that this will not repeat itself again. Hence unless you are completely risk-averse,
you should stick to the floating rate loan.
Should you shift to another lender offering a lower floating rate loan?
This is a worthwhile option. As a rule of the thumb, if the new lender is providing
a floating rate loan that is at least 0.50% cheaper than what your existing lender
gives and the balance tenure is not less than 7-8 years, then this is an option
you should definitely explore despite pre-payment charges that you might have
to pay to your existing lender. You need to be vigilant because you are getting
the best possible floating rate loan in the market as some banks charge higher
rates to existing consumers while giving lower rates to new consumers. So ask
around in the market and keep yourself informed on this score. Remember your ignorance
will prove quite expensive.
What are the other options to balance your monthly budget?
(a) If you have the money, pre-pay a portion of your loan to keep the EMI at the
same level. In most cases, banks do not charge for partial pre-payments and hence
this is an excellent option, provided of course you have the savings to make this
pre-payment. In the given example, you will need to pre-pay roughly Rs. 33,000
for every 0.50% increase in interest rate to keep the EMI at the same level as
(b) If you neither have the savings Interest rates to make the pre-payment nor
any money to pay the increased EMI, then check whether the bank is willing to
increase the loan tenure and keep the EMI at the same level. However, normally
the bank will not increase the tenure beyond the retirement age (normally assumed
at 60 years for salaried people and 65 years for self-employed people)
(c) You can consider taking overdraft loans against your savings instruments (insurance
policies with high surrender values, mutual fund units, shares, etc.) to pay for
the increase in the EMls. The advantage of such loans is that for a small fee,
you get an option to draw up to the limit. You pay interest only for what you
actually utilize and as long as the total amount does not exceed the limit, you
do not have to pay off either the interest or principal. Of course all this is
only a temporary palliative. You should pre-pay the loan from your future savings
or from the drop in your EMls as and when the interest rates drop again.
(d) If neither of the above options are feasible, then you can consider approaching
your existing lender to provide an additional loan on the security of the same
house. You are likely to be eligible for the additional loan as house prices have
gone up significantly in the last two years and your income would also probably
have gone up.
(e) Neither of option 'c' or 'd' are great options as you are actually borrowing
money to repay your existing borrowings which is fiscally imprudent. So, they
must be exercised after due caution.
The best option which remains is to rejig your budget and cut out non-essentials.
The above table is an extreme example to understand the magnitude of the change.
The interest rates were the lowest in the last quarter of 2003. Let's assume the
loan was taken at the lowest possible rate and work out the impact following increases
in the intervening period.