The home loan industry has been seeing good times of late. With demand for housing picking up, home loans continue to remain a priority for a lot of individuals. This is despite the uptick in home loan rates over the last 6-8 months.
Last week saw another hike in home loan rates by most home loan companies to the tune of 50 basis points (0.50%). How will the current interest rate hike affect the borrowers?
To begin with, it will affect both the existing as well as the new borrowers. But it will have an immediate impact on those individuals who have gone for a floating rate loan.
An illustration will help in understanding things better.
Effect of interest rate hike
| Loan amount (Rs) | Rate of interest (%) | Tenure (Yrs) | EMI (Rs) |
| 1,000,000 | 7.25 | 20 | 7,904 |
| 1,000,000 | 7.75 | 22 | 7,904 |
Let us take an individual who had taken a home loan a couple of months ago for Rs 1,000,000 for a 20-year term. As can be seen from the table, the equated monthly instalment (EMI) he is currently shelling out is Rs 7,904.
But after just 2 months into the home loan, interest rates move up by 50 basis points. Since HFCs calculate EMIs based on an individual's income, they do not hike the EMI to reflect the higher home loan rate hike.
This is because they do not want to disturb the individual's salary net of EMI. An alternative, which most HFCs exercise, is to increase the tenure to compensate for the rate hike.
In our example, the individual, instead of coughing up the EMI over 20 years, will now have to pay the EMIs for a total of approximately 22 years. In effect, his net outflow over that period will stand increased by approximately Rs 189,696. Also the home loan tenure went up by 2 years since the individual had taken a home loan only recently.
Had the individual taken a loan say, 6 years ago, the tenure would have gone up by less than 2 years. It would have been in proportion to the remaining tenure, the rate hike and the remaining 'principal' balance.
As far as fresh home loans are concerned, they will be done at the revised rate. And as for borrowers who had taken the home loan at fixed rates, they will be affected depending on the 'fixed rate' option they have taken. (Where are interest rates headed?)
With home loan rates having been revised upwards twice in the past 8 months, what should individuals opt for -- fixed rate loans or floating rate loans? The call on the same really depends on the individual's risk appetite and his understanding of the economic environment.
If an individual believes that rates are headed northwards for some time to come, then he can lock himself into a 'pure' fixed rate loan. However, he will not get the benefit of a fall in rates, if this was to happen in the future.
Individuals who don't have a long-term view on interest rates, but believe that home loan interest rates could rise in the short term, should opt for the fixed rate loan, which is subject to revision periodically. This way he has capped his EMI liability to a pre-determined level.
Conversely, if he feels that rates are likely to head southwards going forward, then he can opt for a floating rate loan, which will give him the benefit of a fall in interest rates. But he will also be hit in case of a rise in rates.
(The figures used in the illustration above are based on those of an existing home loan company. They could vary across home loan companies).
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