RBI Hikes Interest Rates. What Can Home Loan Borrowers Do?

The Reserve Bank has hiked the Repo rate in the first week of May 2022. If your home loan is linked to Repo rate or to any external benchmark, you will soon see one of the following things happen.

1. EMI stays constant and the outstanding loan tenure goes up (that is the usually the default action). OR
2. The loan tenure remains unchanged, but the EMI goes up.

Neither is good for you. Under (1), you pay EMI for a greater number of months. Under (2), you feel the pinch right away as the EMI goes up. Either way, you end up paying more over the loan term.

By the way, even if your home loan interest rate is not linked to an external benchmark (say linked to MCLR), expect no relief. The banks are always very keen to pass on the rate hikes.

What Can You Do?

Be prepared for more such rate hikes. Though I am no expert, I will be surprised if the RBI stops at just 1 hike. You can expect a few more rate hikes. With each hike, your home loan interest rate goes up. With increase in interest rates, your loan EMI goes up or the loan tenure increases by a few months.

Over the past couple of years, we have gotten used to low home loan interest rates. This trend may reverse (no guarantee). As a borrower, you must be prepared. You must see how your cashflows would look if the rates were to go up further. Prepare accordingly.

Or if you want to keep the EMI or the loan tenure unchanged, you must prepay a portion of the loan. In the table below, I have calculated the impact of the rate hike on the EMI and the loan tenure. Have also shown the amount of prepayment required to keep the loan tenure and EMI unchanged.

I consider a home loan of Rs 50 lacs. Loan tenure of 15 years (180 months) and the interest rate of 6.5% p.a.

Impact on EMI/Tenure due to increase in interest rate	Current Level	New Interest Rate
	6.50%	7.00%	7.50%	8%	8.50%
EMI	43,555	44,941	46,351	47,783	49,237
Increase from current level	–	1,386	2,795	4,227	5,682
OR
Tenure (Months)	180	190	203	218	238
Increase from current level	–	10	23	38	58
Prepayment needed to keep both the tenure and EMI unchanged	–	154,206	301,533	442,340	576,966

Your home loan amount may be different. However, if your loan tenure and interest rate are the same, you can easily calculate the change by considering these numbers proportionally. For instance, if you loan amount is 20 lacs and the interest rate moves from 6.5% to 7.5% p.a., your EMI will go up by 20/50*2,795 = 1,118. Alternatively, just go to the loan calculator and calculate the impact for your loan.

While I write that you can prepay the loan partly and keep the EMI/tenure unchanged, this may not be an option for all of us. There are significant sums involved. If you have idle cash lying, you can use the money for prepayment to reduce the impact. Note that prepayment does not mean that you are not affected by the rate hike. You still are. For instance, if the loan interest rate goes to 7.5%, you must make a prepayment of Rs 3 lacs to keep the EMI/loan tenure. That’s Rs 3 lacs extra paid.

How? If the loan interest rate had not changed from 6.5% to 7.5% p.a., you would have paid Rs 43,555 for 180 months. After the rate hike, you still pay that. And you pay Rs 3 lacs over and above. Hence, it is a hit.

More importantly, you can’t do much about interest rate hikes. The key is, how do you manage it? The way EMI calculations work, the hell will not break loose for most borrowers. For instance, for 1% hike, the EMI goes up from 43,555 to 46,375. An increase of Rs 2,735. Should be manageable unless you are running a very tight ship. Budget for more hikes. RBI may not hike further but that is what financial planning is all about, being prepared for adverse events.

Do not dip too much into your emergency fund to reduce the outstanding amount. Emergency fund is not meant for such usage.

If your loan is a fixed rate loan (car loan, personal loan etc.), you need not bother. Your loan interest rate will remain constant. In any case, the hike in interest rates affect long term loans more.