Interest rate impact on home loan

Staying afloat

Sandeep Singh

Posted online: Tuesday, April 17, 2007 at 1720 hours IST
Updated: Tuesday, April 17, 2007 at 1759 hours IST

You can no longer ignore the rising interest rates. The impact of this is clearly visible in the increased EMIs that you pay now on your previous loans, and the extended tenure for which you will be required to pay on a floating rate loan. This is a fallout of the Reserve Bank of India’s response to the rise in inflation and risk in lending to the real estate, car loan and personal loan sectors. The RBI as a policy measure has increased the Repo rate, CRR (cash reserve ratio) and provisioning against real estate lending. This has left banks with little option but to increase their interest rates.
The impactThe interest rates are on a steep rise with floating interest rates surging up from a level of 7- 7.5 per cent a year-and-half back to 11- 12 per cent now. People who have been hit the most are the existing floating rate home loan holders. For them it’s like being in a trap. Surya Bhatia, a Delhi-based financial planner says: “If you can’t prepay or switch your loan to a cheaper rate from another bank, you are stuck with it and can only wait.”
It also means that whatever you thought you have saved, by way of purchasing a house two years back when the prices were low, is all lost.
Property prices have gone up significantly over the past two years. Anshuman Magazine, managing director, CB Richard Ellis, says: “The prices of residential property across the country have gone up by 50- 100 per cent over the past two years.” But the excess amount that you would be required to pay on your outstanding loan amount now, due to the increase in interest rates, wipes off the notional gain by way of increase in property prices.
Figure it outLet us assume that you opted for a 20-year floating rate home loan at 7.5 per cent in September 2005 for purchase of a residential property worth Rs 25 lakh. The EMI for your loan would have been Rs 16,111. Now that the rates have climbed up, your EMI on the amount outstanding on the same loan at the rate of 12 per cent, with tenure revised from 20 years to 30 years, will now stand at Rs 19,978. This takes your total outgo on the loan up from Rs 38.6 lakh earlier to Rs 71.2 lakh.
If we assume that the price of your property went up by 60 per cent during the same period, the value of your house stands at Rs 40 lakh. But the interest cost on your house has gone up by Rs 32.6 lakh taking the total cost of your house to Rs 71.2 lakh.
For a new buyer the impact is even harder. “A new buyer will have to face the impact of both the rising prices of the property as well as the rise in cost on account of interest rates going up on the home loan,” says Bhatia.
What you can doIf you are in a situation where you have a floating rate loan that has gone substantially up, then there are some options for you to explore to bring your costs down. Bhatia says: “In case you have money with you and you took the loan for tax benefits, you need to revisit your calculations and should prepay your loan.”
The part prepayment option is also not feasible for many individuals and hence they need to look for a bank that is offering a cheaper loan and switch the loan amount. Here you need to pay a prepayment penalty of up to 2 per cent on your loan outstanding. If you find the penalty to be lower than the amount you would save by switching, then it’s worth considering.
Going by the above example of a 20-year Rs 20 lakh loan, after paying your regular EMIs for a period of 18 months you are still left with a principal outstanding of Rs 19.31 lakh. If your bank has revised your interest rate from 7.5 per cent to 12 per cent and your tenure from 20 years to 30 years, your new EMI will stand at Rs 19,978. The prepayment penalty in this case will be Rs 38,620. Now if there is a bank that offers you a loan on the amount outstanding at 10.5 per cent, then your EMI comes down from Rs 19,978 (12%) to Rs 17,804 (10.5%). This brings your total outgo less by Rs 7.4 lakh over the total tenure of the loan.
After paying your EMI at Rs 17,704 for 18 months you will recover the prepayment penalty you have paid and the rest goes on to save for you at your existing loan rate. This is a sample case and you need to calculate for your specific case and take a call. Although in most of the cases it fits well.
Should you defer your purchase?If you were planning to buy a house, you must have wondered whether to buy now or later, considering the possibility of interest rates going down. But that is no reason for you to defer your purchase by a year or so. Magazine says: “Property prices won’t come down crashing and they can only go up, though the rate of price rise might slow down.”
According to Bhatia it’s better to buy now than to wait. “If the interest rates stay put there is no reason to defer, if it goes up it is only better to take it now, and if it goes down then with your floating rate loan you will get the benefits of the same,” he says.
Floating or fixed?With housing loan rates rising with every passing month, it is no wonder home loan customers are concerned whether they should take fixed rate or floating rate loans. If we see the impact of the rising rates, it has been only on the floating rate loan holders.
There are couple of factors that come into play when one has to decide between floating and fixed rates. The first and foremost factor is the direction the interest rate market will move. Rajiv Kumar, director and chief executive, Icrier, says: “Inflation has been driving the interest rates.” “The interest rates are peaking so maybe we will stay at these levels for some time and then see the decline,” adds Abheek Barua, chief economist, ABN AMRO Bank,
In such a scenario where interest rates are expected to come down, it would not be wise to get into a fixed rate home loan — the rates are high and you won’t get the benefits of the declining interest rate, which exist in floating rate home loans. So opt for a floating rate loan. Bhatia says: “The difference between the fixed and floating rate is big — 150-200 basis points. The downside risk gets higher than the upside risk, which is why you should go for a floating rate.”
So work out the strategies for your previous loans and do not wait for things to settle down to buy a house. Go ahead with your plans.
‘New loan takers will be hit’Anshuman MagazineMD, CB Richard EllisWhat is your take on the rising interest rates in relation to the housing sector?There definitely has been value erosion because of the rise. The value of transactions in the residential markets has gone down and the growth rate in loan disbursement has come down from 30 per cent to 25 per cent now.
How do you see the individual getting impacted by it?The new loan takers will get significantly hit, as they will find it far too expensive to go for a loan at a higher rate and that too on a costly property.
To be specific, how will the interest rate rise impact them?If the EMI payment increases more than what has been budgeted, then it will strain those individuals unless the salary increase has been significant.
‘Make your purchase now’Surya BhatiaFinancial PlannerWhat do you think an investor should do to reduce the impact of interest rate rise on his ongoing loan?He can explore options like prepaying the loan if he has the money, or switch over the loan to another bank if he gets the loan at a cheaper rate.
Should new homebuyers defer their house purchase decision because of interest rate rise and expectations that they will fall?It’s very tough to say which way the interest rates will move. But either way they go — up or down, it only makes sense to purchase it now. If the rates are to go up, it is only better that you only advance your decision. If they were to go down then you anyway will get the benefit of the low rate on your floating rate loan.
Finally at these rates, should one go the fixed way or floating?You should go for the floating rate loan as the upside risk is lower than the downside risk.

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