How Repo Rate Increase Impacts Home Loan Borrowers' EMI

Imagine you took a home loan to fulfil your lifelong dream of owning a house and had your financials worked out – the EMI amount and duration of repayment everything taken into account. Then, one day, your bank informs you that your monthly payments are set to go up, or that your repayment tenure will have to be extended by 5 or 10 years if you wish to keep paying the same EMI amount.

This is exactly what numerous homebuyers will experience in the coming days with the Reserve Bank of India (RBI) increasing the Repo Rate by 50 basis points on August 5, 2022 – bringing it to 5.40%.

This is the third successive increase in the repo rate this fiscal. Earlier, the central bank had hiked the rate by 40 basis points in May, and again by 50 basis points in June. The combined hikes take away from all the gains that had come the way of homebuyers during the first two years of the pandemic. At the time, the apex bank had announced cuts in the repo rate to boost demand.

So, how does this repo rate hike of 140 basis points this financial year stand to affect Home Loan borrowers? Let’s take a more detailed look.

What is repo rate – understanding how banks borrow from the RBI

As a customer of a bank, when you approach it to take a loan for any purpose – building a house, financing a family member’s higher education, or for any other reason – the bank agrees to lend you the money at a certain interest rate.

Similarly, when banks or other financial institutions need to borrow money over and above what they take from the general public in the form of deposits, they must approach the RBI. The apex bank will accept some securities (like gold or treasury bills) from its customer banks and lend them money at an interest rate called the repo (repurchasing option) rate.

This is done through a repurchase agreement. Thus, commercial banks make up for their liquidity problems by taking overnight loans from the RBI.

What happens to home loan EMIs when repo rate changes

The savings account and fixed deposit returns as well as the interest rates offered by banks on various kinds of loans are all based on the repo rate, i.e., the rate at which they borrow money from the RBI.

In simple terms – if the bank is paying a lower interest to the RBI, it has more cash at its disposal. So, it will be in a position to pass on the benefit of the low repo rate to its own customers.

During the peak pandemic time in India, when the repo rate was down to 4%, the Home Loan Interest Rates went down to as low as 7%. According to experts, now that the repo rate has climbed to 5.40%, the interest on home loans may easily cross 8%.

Basically, home loan interest rates will increase whenever the RBI hikes its own lending rate. Also, unsurprisingly, banks are quick in passing on the burden of these hikes to their own customers.

When this happens, it ultimately comes down to the additional interest that a given bank charges on top of the repo rate. All banks charge a minimum of 3% additional interest on home loans, with some charging more than that. For instance, when the repo rate was down to 4%, the most affordable housing loan was still available only at 7%.

Home Loan EMI Calculators

A Home loan EMI Calculator is a tool to help you to calculate your EMI based on the principal amount borrowed, loan tenure, and interest rate charged by the bank. With this, you can easily know your monthly interest as well as your monthly reducing balance.

For example, the according to the SBI Home Loan EMI Calculator, if you Take a home loan of Rs. 1 Crore at an interest rate of 8.00% and your repayment tenure is 15 years, your EMI would come to Rs. 95,623. If the interest rate remains the same throughout the repayment tenure, you would end up paying a total interest of Rs. 7,212,131 on the borrowed amount. However, if the bank hikes its interest rate to 8.50%, in view of the repo rate increase, your EMI would go up to Rs. 98,474, and overall, you would end up paying an interest of Rs. 7,725,312 (illustrated in the table below).

Tips to reduce your home loan EMIs when the repo rate goes up

As explained earlier, even if the repo rate is low, banks generally charge nothing less than 7% as interest on the credit extended to homebuyers. The percentage of interest that a bank will charge in addition to the prevailing repo rate is decided by the bank.

* In such a scenario, home loan borrowers can opt for the balance transfer option and bring down their EMIs. This method allows customers to transfer their outstanding loan balance to another bank that’s offering lower interest rates on the balance amount.

* Research well and take into account the cost of moving your home loan from one bank to another (processing charges + any other fee that may be levied).

* If, fortunately, you have enough funds, another option could be to settle your loan payment fully or partially. While the repo rate may be up, just reducing the repayment duration will help you save on the interest that needs to be paid.

There are several other routes to optimize your repayment journey and you can choose any of these, depending on your circumstances –

• If you are about to take credit but also have a fund surplus, choose a loan option with a higher down payment. This will bring down your EMI burden.
• If heavy EMIs are not suitable for you, negotiate a longer repayment term with your bank. This will increase the overall interest burden but make the monthly instalments more manageable.
• As a long-standing and valued customer of your bank, you can also try and negotiate the repayment terms, but this will not work always.
• Tip for all: Research your options well and look for banks or non-banking financial corporations (NBFCs) that are offering Best Interest Rates on Home Loans.

High repo rate and its effect on demand

As you would understand by now, a high repo rate means extra payment burden on homebuyers. This, of course, would have some impact on lowering the demand for housing-related investments. Besides, the pandemic is not over and, as a result, annual salary hikes in several sectors are still taking a beating.

The silver lining, as mentioned by an expert in this Financial Express article (Rate Hike: Don’t expect long-term impact on housing sales, say developers | The Financial Express) is that the consumer sentiment continues to remain buoyant, and the actual increase in home loan interest rates by banks is expected to be marginal.