The home loan party is over as interest rates look set to move north.
While fixed deposit holders look forward to better times, home loan borrowers are pulling out calculators to check the impact on their pockets.
Let’s revisit the process of taking a home loan.
You identify a property first. Or you opt for the safer route of getting a pre-approved loan. It gives a clear idea of what you can afford.
The current price of the property plus the interest and charges you pay over the loan tenor is the total price of the house for you. It can shock you at times making you think it’s not worth the price.
But then the main attraction of real estate is that the price appreciates over a period of time. And anyway, you don’t have enough cash for an outright purchase without a loan. So, you go ahead and opt for a home loan.
What are the options available to you?
FIXED RATE HOME LOAN
The rate of interest does not change over the entire tenor of the loan, but fixed rates are pegged 1%-1.5% higher than floating rates.
Fixed rates gain popularity when interest rate regimes are moving upwards. Your liability remains fixed as interest rates increase.
Home loans on fixed rates attract a penalty on prepayment or foreclosure of the loan. So, the impact of balance transfer needs to be calculated carefully.
FLOATING RATE HOME LOAN
The rate of interest is pegged to an external benchmark rate.
1. Repo-rate linked loans
The rate of interest is pegged to the RBI Repo rate and sees an immediate rise or fall.
Hence, you enjoy the party while the repo rate is static or going down, as it happened in the last few years. Home loan interest rates reached a low of 6.5% in some cases.
2. MCLR Loans
MCLR is the abbreviation for marginal cost lending rate.
MCLR-backed loans carry an interest rate specific to the bank, in line with their incremental cost of funds. It takes into account the interest paid on deposits, funds borrowed from RBI and return on net worth to arrive at a lending rate. The rate is adjusted on a monthly basis.
Banks are free to set higher rates of interest for long duration loans, in the MCLR method.
MCLR rates are set to increase as interest rates on deposits and RBI repo rates go up.
3. Semi fixed rate loans
Here the interest rate remains fixed for the first 2-3 years, then gets converted to a floating rate.
It makes sense in times like now, when the interest rates look set to rise for the next 1-2 years.
How Home Loan EMI works for you?
The home loan EMI calculator tells you how much will you pay per month in future.
If you play around a little more, it tells you how the total interest outgo changes with the tenor of the loan.
Lenders may allow you to continue with the same EMI in a floating rate loan, if you cannot afford to pay the increased amount. However, the total number of instalments you pay will increase, spiking up the total repayment amount.
Longer the tenor, higher the total interest outgo.
Decision-making factors to manage your home loan EMIs
1. Your age
Fixed rate loans work fine if you are 55+, and/or intend to repay the loan in 5-7 years.
2. Remaining period of the loan
If the remaining period of the loan is long, a floating rate might be a better option. It gives flexibility of balance transfers.
3. If you are a new borrower
If you plan to avail of a home loan, look for lenders which offer the semi fixed rate facility.
4. Total amount of interest
Numbers matter. Much more so than concepts, and classification as fixed or semi-fixed or floating
Calculate the total amount of interest you pay over different rates, different tenors and different options.
A home loan EMI should ideally not be more than 30% of your net take home pay.
Balancing the two factors above will help you in deciding which is the best option.
5. Appreciation in property prices
The appreciation in prices may vary for different geographies. Check the development plans for the area surrounding the location, and connectivity with commercial and transport hubs.
Calculate a percentage rate per annum.
Compare it with the rate of interest you will pay on the home loan.
It helps you arrive at a better decision.
6. Assessment of the interest rate scenario
How far do you see interest rates moving in the next 3-5 years? It is tough to predict anything for a period longer than that. The only thing that helps is flexibility to opt for Plan B.
Lenders may lower fixed rates slightly and book loans for a longer duration. Despite that, do the rates offered match the interest rates predicted by economists?
The RBI has increased rates by 0.4% and is likely to increase rates by another 1% in 2022. In this scenario, if the fixed rate is 2% higher than the floating rate, it is not the best option for you.
This is only an example, and various permutations and combinations of this are possible.
7. Focus on your priority
Clients do get impressed with a superior level of customer service, and agree to pay more.
But if money did not matter, you’d not be reading this.
What does your employment or business scenario look like? Do you see uncertainty surrounding your monthly income?
In a good situation, monthly income increases over time and EMI load does not seem too heavy. However, if you foresee the discontinuation of a partner’s income owing to family responsibilities or relocation, how do you plan to deal with it?
Keep your focus firmly on total cost, charges and other terms and conditions, before you arrive at a final decision.