Impact of interest rate hike on Home Loans

Introduction

Rajeev had taken a home loan of Rs. 50,00,000 last year to finance his dream house. The Equated Monthly Instalment (EMI) on the loan was within his budget at the time of application. However, since last month, his EMI shot up. 

This is the plight of many home loan takers in India right now because the Reserve Bank of India has hiked its repo rate for the first time in almost four years. Let us understand what is repo rate and why does it affect your home loan interest rate? 

Understanding repo rate 

Repo rate is the interest rate at which the RBI lends to commercial banks in the country. It is a tool that the RBI uses to control inflation. 

Since the beginning of the year, inflation in India has gone up significantly. In April 2022, India’s Consumer Price Index, an indicator of retail inflation, went up to 7.79%. The RBI declared a 40-basis point increase in repo rate to manage inflation. The word on the street is that the RBI will further increase repo rate over the year to control inflation. 

What happens when repo rate increases? 

When the RBI hikes repo rate, borrowing becomes expensive for commercial banks. These banks, in turn, pass on this burden to their customers by increasing the interest rate on products, such as home loans and car loans. 

In this situation, not only new loans become dearer, the rates of the existing loan can also go up if you have taken a floating interest rate loan. In India, most home loans are pegged to the one-year MCLR (Marginal Cost of Funds based Lending Rate) or repo rate. MCLR is the minimum rate set by banks at which they can lend to customers. When the repo rate goes up, so does the MCLR. This has a direct impact on your EMIs as the lending rate will increase for both MCLR and repo based loans

Take a look at this table to understand the impact of rising interest rates on your home loan: 

How to manage an increase in home loan EMI? 

If you are unable to meet the increased EMI requirement on your home loan because of the interest rate hike, here are a few things you can do: 

1. You can request your home loan provider to extend the tenure of your loan so that your EMI remains unchanged. With a longer tenure, your total interest outgo will increase because the interest component will rise. However, it will not increase your EMI burden. 

2. If you have surplus funds, you can consider prepaying a part of your home loan. This will reduce the total principal amount, thereby reducing your EMI or tenure. 

3. You could also consider refinancing your loan at a lower interest rate. If your credit score has improved, there is a possibility that lenders may lend you money at a lower interest rate. 

Additional read: 6 Tips to enhance your home loan eligibility

In summary

An increase in RBI repo rates will definitely lead to a hike in home loan interest rates. If you plan to take a new home loan or have an existing home loan at a floating rate of interest, you can expect your EMI to rise. It would be best to plan your finances accordingly to meet the higher EMI requirement.