Loan EMIs set to go up for borrowers, FD investors to benefit

In a surprise, 2 PM media briefing today, the Reserve Bank of India (RBI) governor announced that key policy rates have been hiked. As per the announcement made, the RBI has hiked the repo rate by 40 bps up to 4.40% from 4% earlier. The last time repo rate was cut was in May 2020 and has been kept unchanged since then. Hike will come into effect immediately. Further, the Cash Reserve Ratio (CRR) has been hiked by 50 bps which will exert further upward pressure on interest rates. It appears that borrowers should prepare for an increasing EMI burden and FD investors can hope for better returns on new FDs.

As per the Governor’s statement, “Based on this assessment of the macroeconomic situation and the outlook, the MPC voted unanimously to increase the policy repo rate by 40 basis points to 4.40 per cent, with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 4.15 per cent; and the marginal standing facility (MSF) rate and the Bank Rate to 4.65 per cent. The MPC also decided unanimously to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.”

Repo rate: RBI Governor outlines reasons for the first hike since August 1, 2018

In a surprise move on Wednesday, RBI Governor Shaktikanta Das hiked repo rates by 40 bps to 4.40% with immediate effect. Wednesday’s hike is the first since August 1, 2018. Governor laid down the following rationale behind the off-cycle rate hike

There are many signals which indicate that this may be the start of an interest rate hike cycle.

As per the global indicators, the retail inflation in the US has risen to 40-year higher to 8.5% in March. Also, the Fed has indicated a hike of 50 basis points (100 basis points = 1%) in its upcoming policy announcement.

Similarly, the retail inflation in India, measured by the Consumer Price Index (CPI), for March 2022 has risen to 6.95%. In April monetary policy, the central bank said that the primary focus is to ensure that inflation remains within the target going forward, while supporting growth. The core mandate of the central bank is to manage retail inflation and ensure that it remains within the range of the 2-6%.

With further possibilities in key policy rate hikes, here is what is likely to happen to FD rates now and what depositors should do. Further, we also tell you what loan borrowers should also expect.

Short term deposit rates may increase first
Whenever the interest rate cycle makes a U-turn from the bottom, it is typically the short to medium term interest rates that are likely to rise first. As far as long-term interest rates are concerned, it will take a little longer for these rates to go up significantly.

Avoid locking deposits for longer term at lower rate
If you are planning to book an FD now or are looking to renew your existing FD, then it will be better to go for shorter term FD, say one year or lower, so that your deposit is not locked at a lower rate for long. Whenever the short to mid-term rates rise, you can start increasing the tenure of the FDs accordingly.

Impact on borrowers
If you are planning on taking a loan, then you better do it soon, as interest rate on loans could start increasing soon.

This hike spells bad news for existing borrowers as well as banks and other financial institutions will soon start increasing interest rates on loans, which in turn means that the loan EMIs will also go up.

How your loan EMIs will be impacted by latest hike.

Loan Amount (Rs)30,00,000
Tenure (Years)20
Current Interest Rate (%)6.8
Current EMI (Rs)22,900
New Interest rate (%)7.2
New EMI (Rs)23,620
Increase in EMI (Rs)720

SBI’s term home loan interest rate for a loan up to Rs 30 lakh for male, salaried borrower. The interest rate is linked to repo rate.

All loans will be impacted by the latest policy decision, be it a home loan, car loan or a personal loan. Here is a look at how each loan will be impacted and what an existing borrower and someone one looking to take a new loan can do.

How new borrowers will be impacted

If you are a new borrower planning to take loan you should act quickly so that you can get your loan disbursed at the prevailing lower rates.

This matters primarily for fixed rate loans like car and personal loans where the EMI remains the same during the entire tenure of the loan. So, the point of entry is crucial. If you take a loan at a time when the interest rate is low (like at present) then you can keep enjoying the rate for the entire tenure of the loan even when the overall interest rate goes up.

However, for home loan borrowers the timing of taking the loan doesn’t really plan an important part as this rate hike may not bring significant difference in the interest payout and EMI payments because these are mostly floating rate loans. So even if you enter at lower rate now you will have to pay a higher rate later when the lender increases its interest rates.

Impact on existing borrowers
If you are an existing borrower of fixed rate loans like auto loan or a personal loan, then the interest rate hike will not have any impact on your loan, and you can continue paying your existing EMIs.

However, existing home loan borrowers will be most adversely affected as most of home loans are on floating rate basis where any such hike is passed on to the borrower. All floating rate home loans taken after October 1, 2019 are linked to an external benchmark as per RBI’s mandate. As most of the banks have selected the repo rate as their external benchmark, a hike in repo rate will most likely mean an increase in loan interest rates. Banks are mandated to revise their external benchmark-based lending interest rates at least once in three months to bring them in line with the external benchmark they are linked to.

SBI’s term home loan interest rate for a loan up to Rs 30 lakh for male, salaried borrower. The interest rate is linked to repo rate.

Whenever the home loan interest rate goes up the first thing which most lenders do is to increase the tenure of the loan rather than increasing the EMI amount. This is not economical for the borrower in the long run, especially when it comes to a long tenure loan like a mortgage.

There can also be scenarios where the lender itself will not allow the borrower to increase the tenure of loan. This happens when the borrower is above 60 years of age. In this case, the lender will increase the EMI amount and will keep the tenure unchanged.

What should a borrower do?
The longer you keep your loan tenure, higher will be the amount of interest you end up paying. As the latest repo rate hike is not substantial, if you can afford the higher EMI then it will help you keep the interest cost low and close the loan early. However, if you are finding it difficult to afford the increase, then you may consult your lender and ask them to increase the tenure (if possible).

If your loan is more than 5 years old, then it will make sense for you to check the interest rate regime (i.e., BPLR, Base Rate, MCLR or External Benchmark Rate (EBR)) under which your loan has been sanctioned. If you have not shifted your loan to an external benchmark linked loan, then it is quite likely that you may be paying a much higher interest rate than what is being charged by lenders on the new external benchmark linked home loan. In case you are paying a higher rate you may ask your existing lender to switch your loan to a loan linked to EBR for which you may have to pay a nominal switching fee.

However, if your lender is not offering this facility or is charging a higher rate even on an EBR linked home loan, then you may consider switching your loan to a new lender. Being a floating rate loan there is no penalty for switching. This means the only factor that you have to check is the processing fee and charges of the new lender and compare it with the interest advantage that you would get from the switch. If the net benefit appears attractive you can make move. Borrowers should consider balance transfer when the interest rate reduction is 0.5% or more.

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