In the last 15 months, the Reserve Bank of India (RBI) has hiked policy rates by 300 basis points. One basis point is one-hundredth of a percentage point. Lending rates have followed suit and have risen by almost 3 percentage points. For you, it has meant a steadily increasing equated monthly instalment (EMI) burden. Since the home loan is likely to be the biggest liability you have taken, the quantum of EMI hike would be the biggest, too, and may pinch you the hardest. To accommodate that bit extra, you would have altered your finances and savings pattern. But with another round of rate hike on the cards, you may need to look closer at your finances.
While cutting corners is the first step, remember that every case is different and the strategy to handle the increase in EMIs varies too. You could pay the increased EMI or increase the tenor. Switch the loan to another lender or ask the lender to restructure the loan. Dilute investments to make part payments to reduce the EMI burden or ask the lender to defer the EMIs by a few months. Ensure your choice suits your situation.
We spoke to three loan borrowers to find out how they are coping up and what they plan to do if there are further rate hikes. We also spoke to certified financial planners to find out whether they are on the right track. This exercise is to give you a direction on the basis of the specific situations and the planners’ take.
Shweta Naik , 30
Nitin Naik , 30
Then (2010): 9% (Interest rate) Rs 41,349 (EMI)
Now: 10.75% Rs 46,732
Planner’s solution: Don’t increase the tenor of loan even if EMI increases, but ensure EMI doesn’t cross 40% of monthly salary.
Shweta Naik and Nitin Amin fell in love when they met at school reunion and got married in 2009. Filled with the verve owing to the marriage of choice, they bought a house soon after in 2010. While Naik works with a fund house and pores endlessly over books, Amin is the creative one and works as an animation artist.
Photo by Hemant Mishra/Mint
Like most home loan borrowers, they too have seen a hike in what they pay as EMI. When they took their home loan for a tenor of 20 years last year, it cost them 9%, they are now paying 10.75%, translating to an increase of about Rs5,383 in their EMI.
Their savings: “I wanted to start investing Rs5,000 in mutual funds (MFs), but now I pay an increased EMI. So my plans to increase investments in MFs and buying insurance have been hit,” says Naik. As of now, they have a few systematic investment plans and manage to save around Rs8,000 per month.
But to maintain their savings rate, they have cut down on lifestyle expenses, such as spending on theatres or going out every weekend. “We still watch movies, but instead of going out every weekend, we watch some movies on the DVD,” says Naik.
The couple had decided not to buy a car, but will now settle for a bike to cut costs. “A car would mean another EMI burden of at least Rs6,000,” says Amin.
But they fear another increase in rates may rock the boat. “I am expecting a letter from the bank and this time, the interest rate may go up to 11.25%, which means our new EMI could easily go up by another Rs2,000-3,000.” They haven’t made up their minds whether they should go for an EMI hike next time or a tenor hike.
The right strategy: Mumbai-based financial planner Pankaj Mathpal has a simple solution for them. “If interest rates increase again, I recommend the couple to check their cash flow and increase their EMI if they can afford it instead of increasing the tenor. But they must see their comfort level. They should ensure that their total EMI does not exceed 40% of their monthly income.” Increasing the tenor makes the loan expensive overall.
Abhay More , 39
Then (2004): 7.25%, Rs 9,177
Now: 10.50%, Rs 12,500
Planner’s solution: Instead of saving in a recurring deposit, More can increase his EMI amount. With the same EMI, he should choose an investment vehicle that gives a higher return.
Abhay More is a typical sandwich generation case with growing kids and an aging parent to look after. He bought his Pune flat, where he lives with his family, in 2004 on a loan from a foreign bank at 7.25% rate of interest and a tenor of 15 years.
Photo by Sandesh Bhandare/Mint
After several rate hikes and switching a loan once, his interest rate is 10.50% and total loan tenor 19 years. He’s been able to manage his loan so far. “My wife, Snehlata, also works and the double income helps,” he says.
His savings: More has been regularly setting aside savings for years now. Increase in the EMIs won’t hurt him much, but it will definitely eat into his savings. Currently, the More couple is able to save around Rs8,000-9,000 a month. He also has some investments in physical gold and silver and a systematic investment plan (SIP) of Rs2000 a month. He saves Rs2,000 per month in an RD to part-prepay the loan at the end of every year. This, he thinks, will reduce his EMIs.
The right strategy: But Suresh Sadagopan, Mumbai-based financial planner, doesn’t think opening an RD makes sense. “If possible, he should increase his EMI by Rs2,000 every month. He is paying a loan at an interest that is higher than what he would be getting in an RD.”
But what if he prefers prepaying the loan and not increasing the EMI? Then he should look for some other investment instrument, the planner says.
For someone who is financial cautious like More, who chose to buy a second-hand car, increasing the tenor of the loan or switching the loan is no longer an option.
Sadagopan says, “There is no point in switching the loan to another lender since interest rates should start correcting in around six months. If More wants to accumulate funds to prepay, he could look at quarterly interval funds, which will give a return of 7%-plus, till February-March. After that, a fixed maturity plan that matures in April 2013 can be considered.”
Binu Baby Thomas, 26
Then (Jan 2011): 9.05%, Rs 18,000
Now: 10.75%, Rs 21,000
Planner’s solution: Increase the tenor or switch to a low-cost loan. Thomas needs more cash flow since she lives alone in Mumbai and has no emergency corpus.
Binu Baby Thomas left her hometown Baroda and came to Mumbai for a job. Six years down the line, she still feels homesick and perhaps that’s the reason why she bought a house in Baroda. She took the loan earlier this year at 9.05%; the rate is now up by 170 basis points. “If the interest rate is increased any further, I am really concerned how I will be able to manage the EMI,” says a concerned Thomas.
Photo by Hemant Mishra/Mint
Her savings: Staying alone in a city like Mumbai does not come easy. Between managing her daily expenses and sending some money back home, she has little to spare. Says Thomas, “I try and maintain a low consumption lifestyle and manage to save Rs 2,000 a month as of now.” Her loan tenor is 20 years.
She invests this saving in a recurring deposit (RD) to be able to prepay parts of the loan at regular intervals. She also uses her bonuses to prepay the loan. She has a few mutual funds, but hasn’t been able to put aside an emergency fund.
The right strategy: So is Thomas on the right track? “No,” says Ranjit Dani, Nagpur-based financial planner. “She is very tight on cash flow and needs to set aside at least three months’ salary as an emergency funds in a savings account.” Since she is staying alone, having an emergency fund is crucial, says the planner.
Like most people, Thomas thought her credit card could be used for an emergency and never thought of building a contingency fund. But using the cash withdrawal facility of a credit card for an emergency isn’t a great idea. “Unless, it’s a life and death situation, never withdraw cash on your credit card,” says Dani.
What’s the solution? Currently, her RDs offer 5-6% rate of interest, but give poor liquidity. In other words, no immediate cash flow. “She should actually look at decreasing the EMI burden and ask her lender to increase the tenor of the loan. That way, she will have a surplus and cash flow won’t be an issue.” Increasing the tenor would make her loan expensive, but it’s the best option for her. “If she isn’t comfortable increasing the tenor of the loan, she has to seriously look into switching the loan to another lender, who offers a lower interest rate.”