How does a rise in repo rate impact home loans? Expert decodes – what should buyers know?

The monetary policy committee (MPC) of the Reserve Bank of India (RBI) on December 7, 2022, announced a fifth straight hike in the benchmark interest rates by 35 basis points to 6.25 per cent with a 5:1 unanimous voting by a six-member panel.

Repo rate revisions are RBI’s most effective tool to tackle inflation. As most of the retail loans are linked to the repo and hence any change in the same impacts the interest rate of the loan taken by a consumer.

Repo rate hike then causes the consumer to shell out more towards interest payments of the loan taken and can have an impact on his overall household budget.

What is a Repo rate?

The Repo rate is the rate at which commercial banks borrow money from the RBI to meet their short-term fund requirements. Citing the most recent example, a hike in the repo rate by 225 basis points (bps) to 6.25% this year increases the cost of borrowing in the system and hence the lenders are forced to pass on the impact of Repo to borrowers or absorb the cost by taking an impact on margins.

How are home buyers affected?

The immediate impact of a rate hike is that, if the home loan is taken on a floating rate, the interest rate and interest outflow for the tenure will increase. Broadly speaking the recent hikes would not pinch the borrowers much because last couple of years the Repo rate was at historical lows and while offering Home Loans most lenders restrict the EMI amount to 40-50 per cent of the monthly income.

As the income of consumers also would have increased in the last few years the current rate hike should not impact the household monthly budget by any significant amount.

In case the consumer has taken a loan on a fixed rate the Repo hike will not have an impact and the rates will be fixed till the agreed reset dates and conditions as per the agreement.

What can buyers do when buying a Home Loan?

There are two sets of consumers who get affected by the rate hikes, one who already has a loan and servicing it, and the second who had started to look out to buy a new home in the near future.

Consumer who already has a home loan has a couple of options to handle the rate hike, first, they can approach their lending institution and ask increasing the tenure of the loan to adjust the increased EMI in such a way that the EMI remains the same, but the duration of payment increases to offset the hike.

With this, there will be no immediate increases in EMI but a greater number of EMI would have to be serviced in the future. Second, if you have an excess lumpsum fund and the same is not earning post-tax same return as the interest rate on home loans, it would be prudent to prepay a few extra EMIs upfront so that the principal comes down and overall interest outflow remains within comfortable limits of the person.

For the second set of customers, who are thinking to buy in near future, need to assess the increased overall outflow and recalculate the overall budget for the purchase and also look out for financial institution which offers low rates and a good customer experience to get a good deal.

(Authored by Abey Abraham, General Manager & Business Head – Housing Loan, South Indian Bank)