Interest rates are on the upward curve since March 2010, with the Reserve Bank of India (RBI), in an effort to control inflation, consistently hiking repo rates. Currently the repo rate stands at 8%, with the most recent RBI hike of 50 basis points (bps). Most leading banks followed suit with an interest rate hike of 50 bps recently. This in effect will mean that things are going to be costlier on the borrowing front and could take time to ease up.
Take the example of Sanjay, who took a loan of Rs30 lakh in February 2009 for a tenor of 20 years at an interest rate of 9.75% per annum with the then retail prime lending rate (RPLR) at 14.5% per annum. He was paying an equated monthly instalment (EMI) of Rs28,456. Today with the RPLR at 16.5% per annum, Sanjay would need to pay an EMI of around Rs32,204 at an interest rate of 11.75% per annum. The RPLR for an existing customer will follow its own curve based on the spread (difference between the RPLR and the interest rate) at which he took his home loan in 2009. Sanjay’s spread, when he took his home loan in 2009, was 4.75% (RPLR of 14.5% minus the interest rate of 9.75%). To calculate his current interest rate, you need to subtract his spread or the discount he was eligible for on his loan from the current RPLR: 16.5% (current RPLR) minus 4.75 (earlier spread), which comes to 11.75%. Also, do remember that to calculate Sanjay’s current EMI, all the hikes and decrease in interest rates he has gone through so far has to be factored in to arrive at an accurate estimate of his current EMI. Accordingly, the difference in EMI is Rs3,748: Rs32,204 (current EMI) minus Rs28,456 (earlier EMI). If the interest rate cycle continues its upward march, more hikes are likely in the future.
In such a scenario, let’s say Sanjay shifts his loan to another lender offering 10.75% to new borrowers soon after his interest rate has been hiked. His EMI then would decrease to around Rs30,400 and the difference in his present EMI would be Rs1,804 (Rs32,204–Rs30,400). However, one needs to factor in the loan switch fee or prepayment penalty (which is still in vogue with several banks except in instances where you pay through your own sources) of around 3% of the outstanding loan amount, which will work out to around Rs85,800 for Sanjay’s outstanding loan amount of around Rs28.6 lakh. This is a huge sum and he needs to consider if it makes sense to make such a move in a rising interest rate scenario.
What if after he shifts his loan, the interest rate is hiked again? His EMI could again increase by Rs1,000-2,000 in consecutive hikes depending on his interest rate revision cycle which can be three months or six months or some other time frame defined by the bank. This could diminish the value of a loan transfer especially in the light of the prepayment penalty paid.
Further, in a home loan transfer, the paperwork, property verification process, among others, will have to be done afresh and you need to take care that your loan transition from one bank to another is smooth.
Hence, it would be prudent to wait for loan interests to reach a stage from where it starts falling down. If you shift your loan at that point, you will have the time advantage since with each interest cycle change, the interest rates will go down.
Increase in tenor
Banks generally provide an increase in tenor rather than the EMI in most instances. What if you are stuck between a rock and a hard place, knowing that you will soon have difficulty coping up with your EMI? You should try talking to your bank and increase your loan tenor if it’s possible (but this would mean that your total interest outgo will go up). If further increase in tenor is not possible you can try and see if it is possible to liquidate some assets to prepay a significant sum that can bring down your outstanding loan amount, helping you bring down the EMI.
Prepayment makes sense
In fact, you should always start prepaying in small amounts over a period of time once you are eligible to start prepayment to keep your EMI under control. This will help you keep your loan manageable during times when interest rates peak. With such measures in place, you can afford to wait and time your loan transfer right. However, remember to talk to your bank first to see if you can negotiate existing interest rates on your loan based on your good repayment track record and your relationship with them.
Illustration by Yogesh Kumar/Mint
Adhil Shetty is CEO, BankBazaar.com.
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