[Explained] What Should Your Home Loan Repayment Strategy Be When Interest Rates Rise


Rates are expected to rise by 200 basis points.

Inflation is skyrocketing. And so, a firm decision by the Reserve Bank of India to bring inflation under control was expected. After an emergency meeting in the first week of May, the RBI’s Monetary Policy Committee (MPC) raised policy rates by 40 basis points. As a result, the current repo rate stands at 4.4%.

After the hike, many banks raised their benchmark external policy rate. Experts estimate that interest rates should increase by 200 basis points in 2 years. Borrowers who are already servicing a loan should increase their monthly equivalent payments (EMI) or face an increase in tenure. This will place an additional burden on them.

If you’re managing a home loan and wondering how to handle your IMEs, here are three strategies you can consider:

Prepayments are the best strategy

Borrowers who benefited from a loan when rates hovered around 9.5% may have benefited from the low rate regime when rates hit the low of 6.4%. They might have refinanced their loans at the lower rates to reduce their EMIs and tenure. New mortgage borrowers could feel the effects of the rise in key rates. A rate hike would mean an increase in EMI payments and a substantial increase in loan terms. For example, if you have a home loan of Rs 50 lakh for 20 years at an interest rate of 7%. Your EMI and interest payable, in this case, would be Rs 38,765 and Rs 43.03 lakh respectively. Supposing the interest is revised and increased to 7.4%, your payable EMI would be Rs 39,974 and the interest would be Rs 45.93 lakh. Your mandate can also be extended by approximately 18 months in this case.

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This is where prepayments help. This not only reduces your interest charge but also reduces additional EMIs. So, in addition to your regular EMI payment, you can use any deals, bonuses, increments, or other funds that you can easily use to make a lump sum payment on your loan in addition to your regular EMIs. Home loan prepayments involve the partial or full repayment of your loan while the loan is in service. Partial prepayment of home loans will help reduce outstanding principal, interest payable, and loan term while reducing your EMIs.

Suppose you get a cash surplus of Rs 1 lakh in this example. If you decide to use this excess fund to prepay this home loan, you will save an interest payment of Rs 2,67,399, and your tenure could be reduced by nine months. This would therefore reduce the overall outstanding principal you owe, the EMIS and the remaining term of the loan.

This can allow you to be debt free before the end of your loan term and save a large amount of money that you can invest. Remember that you may not be able to use your excess funds for your existing investments to achieve this financial goal. So do your math. Prepay if your investments are well placed and you are perfectly able to use this surplus.

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A systematic approach to prepayments

Rates are expected to rise by 200 basis points. Suppose there is a rate hike of 100 basis points. New borrowers in such a scenario can consider reducing the loan through a systematic approach of prepaying 5% of the outstanding loan amount once per loan year. So, for example, you have a 20-year loan. If we assume the interest rate is constant, you might be able to pay off your loan in 12 years.

Paying 5% of your outstanding loan amount would ensure that nearly two-thirds of your loan is repaid with your regular EMIs, making them more efficient. It’s a systematic approach because it allows you to prepay regularly without compromising your other financial goals, such as saving for retirement and children’s education. This way you will be debt free faster and you will also have money to build wealth.

Alternatively, if your finances allow it, you can also consider increasing your EMIs. It will be beyond your usual NDEs. For example, if your regular EMI is Rs 35,000, you decide to pay Rs 45,000, the surplus of Rs 10,000 is adjusted against the principal. This will speed up the servicing of your loan each month. You can increase your EMIs based on rising income to get out of debt faster.

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Refinancing is another way to deal with paying off your loan when rates rise. Compare the rates offered by the banks on the market. Move to a lender offering loans at a lower rate than you currently have. You can try to explore a lower rate through a refinance with your lender. Keep in mind that there will be a processing fee. Opt for a refinance if you have more than half of the term of your loan remaining.

Repay your loan within a specified time

This is a slightly aggressive move in case of rising rates. Your objective here should be to bring the mandate back to the same level as before the rate hike. For example, you have been managing a loan of Rs 50 lakh at 6.7% since May 2021. After 13 EMIs, your rate goes to 7.1%. After being reduced to 227 months in May, your term increases to 243 months in June. You can bring the loan term down to 226 by a strategic prepayment of Rs. 175,000 in June. This prepayment and your regular IME will bring your tenure back to 226 months by July. After that, you can repeat the process to close your loan within the agreed time frame whenever there is a rate hike. And when the rate drops, you’ll be in a better position.

Last but not least

After taking out a home loan, your goal should be to service your loan regularly. Your strategy should depend on the current interest rate and inflation. If rates are low, you can continue to pay your regular EMIs and invest your excess money. However, when interest rates are high, the smart choice is to pay a loan with a higher rate, such as 10%, than to earn 8% of a FD.

Keep up to date with loan rates and their impact on your EMIs and interest payments. Do your math to find out which strategy is best for you. The idea is to take out a loan to achieve your financial goal and, at the same time, pay it off strategically to get out of debt faster.

(Disclaimer: The opinions expressed in this column are those of the author. The facts and opinions expressed here do not reflect the views of www.timesnownews.com.)


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