After trending at multi-decade lows, mortgage interest rates are on the rise again. Indeed, the Reserve Bank of India raised the key repo rate by 50 basis points in its last policy review in order to rein in the inflation spiral. The repo rate now stands at 5.4%. This is the third consecutive rate hike after the Reserve Bank of India raised its key rates by 40 bps and 50 bps respectively in May and June.
Most experts believe this is not the end of the rate hike cycle. Given that inflation is expected to continue to be above the RBI’s tolerance level, the central bank may increase the repo rate by 0.5% in October. As a borrower, you must be prepared for these increases.
Home loans issued since October 2019 are indexed to the repo rate. Each time the repo rate is revised, the home loan rate will be revised by an equal margin, usually once per quarter. Normally, this rate change results in a duration adjustment. For new borrowers, as rates rise, loan terms will lengthen. A total rate hike of around 140 basis points so far, with more to follow in October, means new borrowers would have to pay dozens more EMIs.
To facilitate repayment and manage rate changes, banks normally do not change the EMI during a rate change. Only the tenor changes. As a result, you do not feel the financial burden and the additional interest is paid over a longer term while your EMI remains constant. But as a borrower, how do you manage your EMI burden after the hike? Here are some steps you can follow:
Prepayment to reduce occupancy time
Prepayment is an effective way to reduce term, outstanding principal and overall interest expense. You can use any excess money such as a raise, bonus or other windfall to make a final payment on your loan. Your regular EMI payment continues simultaneously. Home loan prepayments allow you to partially or fully repay your loan during the term of the loan service. For example, if you have a loan of Rs 30 lakh at 7.4% for 20 years, your EMI would be Rs 23,985. After the review, your home loan rate would be 7.9% and your total interest would be revised at Rs 29.77 lakh. However, if you keep the same EMI, your loan term will extend by 24 months after a rate hike. You need to estimate in this example the amount of the prepayment that would help clear the additional 24 months of EMI. Once your original money order is back, you can continue with your regular EMI payments. If the rate goes down in the future, you will be in a better position to get rid of the debt.
Prepay 5% of your outstanding loan each year
If you are early in your loan term, you may want to consider a systematic approach to reducing the loan by prepaying 5% of the outstanding loan amount once per loan year. For example, if your loan has a term of 20 years, prepaying at least 5% of your outstanding amount at the same interest rate would reduce the term of your loan to 12 years. With that, paying your regular EMIs would guarantee repayment of nearly two-thirds of your loan.
Increase your NDEs
If your finances allow it, you can opt for higher EMI payments. This will instantly reduce your interest stream. For example, if you pay Rs 30,000 as an EMI, but decide to pay Rs 40,000 in one month, the additional Rs 10,000 will be adjusted against the principal. This will speed up the payment of your EMIs each month and help you get out of debt faster.
Refinance at a lower rate
You can switch to a lower rate to reduce your EMI consumption. However, before doing so, compare the rates available and the costs involved. You will incur a nominal processing fee if you switch to a lower rate with your current lender. If you choose to refinance with a new lender, you will have to pay stamp duty and processing fees. So do your math to find out if refinancing provides real savings. Another great way to reduce your loan burden is, when you refinance at a lower rate, to keep paying the same EMI amount to pay off your debt faster. Remember that refinancing is only useful when you are more than halfway through your loan term.
A loan helps you reach your financial goal. However, when you take one out, your goal should be to pay it off in the optimum amount of time so that you are debt-free and have more money for savings, investments, and fulfilling other aspirations.
The author is the CEO of BankBazaar.com. The opinions expressed are those of the author.
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First published on: 2022-08-18 at 16:55:13
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