How will changing interest rates impact home loan EMIs

[ecis2016.org] With many banks lowering their lending rates, we examine the impact on the home loan segment and the factors that borrowers need to be aware of, to get the best deal

Interest rates play a key role in the home buying decision, when one opts for a home loan. Presently, the interest rate on home loans, is around the 8% mark, which looks very attractive, if compared to what it was 3-4 years back.

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Overall effect of small changes in interest rates

Home buyers usually opt for a floating rate home loan. If the interest rate falls immediately after taking the home loan, the borrower may have to wait for one year for a revision, as most banks have home loans based on the 1-year MCLR rate. The home loan tenure normally ranges around 20 years, which is a very long period and even a small increase or decrease in interest rates, can have a significant impact on the overall cost of the property. As shown in the following table, a variation of 0.25% in the interest rate for a 20-year loan of Rs 30 lakhs, could impact the interest outgo by approximately Rs 1.14 lakhs.

[ecis2016.org] Manage your home loan smartly, as interest rates dive

Home loan interest rate outlook

“Even though the Reserve Bank of India (RBI) did not cut the repo rate, in its recent monetary policy review, home loan interest rates may still fall. Banks can now lend more to home buyers, as the RBI reduced the amount of money that banks have to set aside as security on home loans, from 0.4% to 0.25%. The statutory liquidity ratio has also been reduced by 50 basis points, which means that banks now have more capital to lend. This can lead to lower home loan rates. Banks have already been aggressively cutting home loan rates. In the next 12 months, the interest rate may to reduce by 25-50 bps,” suggests Ajay Jain, executive director – investment banking and head real estate group, Centrum Capital Ltd.

How much EMI should home buyers pay, in the current market?

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Experts believe that borrowers should take into consideration one’s current cash flows and future cash flows, while deciding the EMI payment. Banks are also flexible in keeping a lower EMI in the initial year. Huge EMIs, which eat up a major chunk of your earnings, could lead to financial distress, in case one has not taken into consideration any unforeseen events. One should opt for aggressive EMI payments, when the cost of borrowing increases, or if the borrower has sufficient liquidity.

How to decide an appropriate tenure for the home loan

Amit Wadhwani, director of Sai Estate Consultants, explains: “A borrower should decide the home loan tenure, based on the following factors:

• Income: The EMI should not be more than 55-60% of the monthly income. It is good to keep the EMI to a maximum of 40%.
• Amount of the EMI: Lower the tenure, higher will be the EMI. It generally differs from place to place and family to family, but if one has the capacity to pay higher EMIs, it is advisable to take the lowest possible tenure.
• Purpose: It is also important to understand the purpose of the loan, i.e., whether the property will be used for investment or for self-residence.
• Age of the borrower: The most ideal way to calculate the home loan tenure, should be 60 years, minus the age of the borrower. That should be the maximum tenure of the home loan.”

Before finalising on a home loan, one should understand the interest rate calculation and the EMI combination. Generally, the initial EMIs include a major chunk of interest and minimum principal repayment. One should possibly negotiate on the same with the lender. Also, understand whether the interest is calculated on a reducing balance method. One can also opt for flexible products, like overdraft facility, with drawdown power.

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