After the monetary policy committee’s meet concluded, the Reserve Bank of India (RBI) raised the repo rates by 50 basis points on Friday. This is the fourth consecutive hike in as many MPC meets, and the third consecutive hike of half a percentage point.
The immediate impact that borrowers can foresee is a follow-up increase by commercial banks of home loan interest rates. Consequently, retail loan borrowers can either opt for prepayment of their loan or for extending the tenure of loan to keep the EMI amount constant.
This begs the question whether loan borrowers should opt for loan’s prepayment and what impact will it have.
A primer on ‘Inflation & Your Loan’ by BankBazaar for June 2022 states that the rate hike of a total of 100 basis points can have a “profound implications for small borrowers”.
“For example, if someone took a loan of 6.5 percent for 20 years, a rate hike to 7.5 percent may increase their loan tenor to around 24 years and at 8 percent, it could be nearly 28 years,” states the report.
Investment advisors and finance experts unanimously suggest the loan prepayment to reduce the interest outgo on total loan.
“The increase in repo rates will have a direct impact on the home loan interest rates. After the increase in repo rates, bankers will most likely reach out to borrowers to ask if they want to increase the amount of EMI or the loan tenure. So, if someone has surplus cash, one can do the prepayment to avoid paying a higher interest on loan. By keeping surplus money in the bank or by investing in debt funds does not offer a reasonable return anyway. So, it is the ideal time for loan prepayment,” says Sreedharan Sundaram, a SEBI-registered investment advisor, and founder of Wealth Ladder Direct.
“Borrowers can prioritise pre-payments to cut down on loan interest. This will help them in reducing their loan tenors and EMIs. A time like this calls for people to calibrate their finances to adjust for these difficulties. If you took a home loan at 7 percent for 20 years, your per lakh interest is ₹86,071. Your per lakh EMI is ₹775. If your rate goes to 8.9 percent after 3 months, you had 237 EMIs left but now it could theoretically go to 410 months assuming the same EMI. At this stage, if you made an immediate pre-payment 17 times your EMI, your tenor reduces to 236 months,” said Adhil Shetty, CEO, BankBazaar.com.
Can invest in equity funds via SIPs
Some experts opine that the rate hike cycle can be leveraged to prepay the loan, and the savings resulting out of reduced EMIs can be invested further in equity mutual funds via systematic investment plans (SIPs).
“The repo rates have risen sharply in the past few months and now it makes a lot of sense to do part payment of some of the home loan. This way, one can cut down on either the loan tenure, or the EMI component. And whatever one ends up saving on EMI can be further invested in mutual fund SIPs since the equity valuations have moderated lately. Let us imagine if your EMI is ₹30,000 and after pre-payment your EMI reduces to ₹24,000 then the saving of ₹6,000 can be invested in equity mutual funds via SIPs,” says Amol Joshi, founder of PlanRupee Investment Services.
For the unversed, the banking regulator raised the repo rates by 40 basis points in May followed by 50 basis point hike in June and then again in August. After 140 basis points increase during the past three policy meets, the repo rate has increased to 5.4 percent. And after the latest hike of half percent, the current hike now becomes 5.9 percent – highest in three years.