The news of hiked repo rate by RBI is in buzz as the same has been increased after almost 4 and half years. On the 6th day of June 2018, RBI has announced the revised repo rate of 6.25% which was previously 6%. This means that the interest rate has been increased by 0.25% or 25 basis points. Everyone who is connected to financial institutions in terms of a loan or credit is worried about the impact of the same on their loans. But before we plunge deep into the matter and find the ways to come out of the same, lets us first understand what the repo rate is and its impact on our loans.
What Is Repo Rate?
In the simplest way of explaining, the repo rate can be explained as the rate at which the RBI lends money to commercial banks. All the commercial banks need to borrow money from RBI for which they need to pay an interest to the RBI. When the repo rate of RBI is increased, the commercial banks makes its borrowers pay an increased interest rate in turn. So an increased repo rate means an increased lending rate on loans of every kind.
Impact of Hiked Repo Rate On Loan EMIs
The increased repo rate will have a direct impact on existing and upcoming bank loan borrowers. Whenever the repo rate gets a hike, the banks increase the MCLR (Marginal Cost of funds based Lending rate). Most of the loans nowadays (especially the home loans) are linked with the MCLR of the bank. The loans with a floating interest rate will have to pay more on interest payment because of increased MCLR i.e. the interest rate.
Impact Of Hiked Repo Rate On Existing Home Loan Borrowers
The hiked repo rate or in other words the increased MCLR will not have an immediate effect on existing home loan borrower. Existing borrowers will not see any changes in the EMI amount. The latest home loan interest rate will make a change in the tenure of the loan instead of the EMI amount. A borrower will have to pay the same amount of EMI but the number of EMIs will be increased or in other words we can say that the loan tenure will be increased.
Here we have an example to understand numerically how an increase of 25 basis points will impact the total outgo of a loan.
Let’s say you have a loan of 30 lakhs for 20 years at the interest rate of 8.30%. With an increased MCLR of 25 basis points, your interest rate will become 8.55%. In the present rate of interest, your total interest outgo is ₹ 31,57,488. After implementing the revised interest rate amount which you will need to pay ₹ 32,71,131 in the name of interest payment. So we can find that there is a difference of ₹ 1,13,643. In the same way along with a high loan amount and longer tenure, you are to a quite big amount because of this hiked repo rate.
Smart Steps That Can Be Taken To Reduce The Interest Rate Burden
1) Increase EMI Not Tenure
This is the ground rule to bring down the housing loan interest payment. A bank credit interest rate is charged in a compound interest rate. This means a longer tenure loan will be costlier than a shorter tenure loan of the same amount. As mentioned above, the repo rate hike will not have an immediate effect on the EMI amount but the tenure will be stretched. In such case, if you want to minimize the interest payment, you can make an agreement with your lender to increase the EMI amount instead of increasing tenure. By increasing the EMI you can save a significant amount in interest payment.
The part payment is one of the most effective tools to bring the cost of borrowing down. It is advised by many financial experts that instead of investing your surplus money for a low return, you can better pay off your loan. The savings you make on interest payable will be more than the returns of your investments. A home prepayment has a manifold effect on the borrower. With a prepayment of the home loan, you can reduce your tenure. A reduced tenure will make you debt free much ahead of the predetermined time. A part payment gives you the best results when it is done at the starting of the tenure. But the thing to be remembered here is that a part payment does not make any change in interest rate but it brings the interest payment down by decreasing the tenure.
3) Switch Lender for A Better Interest Rate
Switching lender can help you in the situations like the present. We know that the repo rate has been increased by 25 basis points but it doesn’t mean that all lenders will also increase the interest rate by 0.25% only. Some lenders may increase its MCLR by more than 0.25%. If your lender is also one of them then you can switch the lender for a better deal. The lender switching is called ‘home loan balance transfer’ in the technical terms. One can make a home loan balance transfer only after completion of 18 months of EMI payment. One must compare home loan interest rates with a number of lenders before switching the loan. A decrease of 1% or less in interest rate can also make you save a huge amount by the end of the tenure.
The Bottom Line
The fluctuation in the banking sector is not a new phenomenon. It has always been there and the same is certain to be repeated time to time along with inflation. We, the commoners, have to fight the situation to find way out and save our hard earned money as far as possible. If you are an existing home loan borrower or a potential one then the mentioned tips and tricks will definitely help you to fight the inflation in house loan rates.