Don’t let rates rattle you

Home buyers and owners must logically assess the impact of higher home loan rates

Even before Lousie, who is ever pessimistic about home ownership, opened his mouth, the others in the metro train knew what he was going to say.

“It is terrible that the only positive in the housing space — low interest rates — is fast disappearing,” he said. Predictably, others nodded.

All, except Rosie, who could very well be the person seen smiling in property ads.

“Not at all, and I will tell you why,” she said.

Real impact

“Rate hike by the RBI need not always translate to higher interest rate on home loans.

“And even if it does, you can claim the interest paid as a deduction from your total income,” she said.

“...under Section 24,” added Housie, who is a young rational person, whose only notion of home is the home page on a web browser.

“Interest deduction maxes out at ₹2 lakh and you reach that even with a loan of ₹25 lakh,” said Lousie.

“And a rate hike by the RBI means that cost of borrowing will increase in the system.

“That applies to finances for builders, too, and so prices would increase,” he contended.

Rosie said: “House prices are a factor of market demand and supply. Given the current market, builders may not have much room to increase prices. In fact, they may be more willing to negotiate if they have higher-interest rate loans.”

Housie explained: “To a home owner, the real impact on EMI is probably not substantial. Check this. SBI’s home loan rate is currently 8.65 per cent for salaried borrowers, for a loan of ₹30-75 lakh and a 10-year tenure.

“So, if you take a loan of ₹50 lakh, what you pay as EMI is ₹62,395 per month — ₹24.87 lakh as interest — over the 10 years. Now, if the rate increases by 25 bps to 8.9 per cent, EMI increases by ₹673 a month, and the additional interest outgo over a decade is ₹80,752.

If the rate increases by 50 bps, the additional interest outgo is ₹1.62 lakh.

“That is not much, considering it is a big-ticket item and the time period is long,” he concluded.

Rate direction

“But you are assuming that these rates will stay the same over 10 years. That is not what most people have,” Lousie argued.

“And many would be on a tenure of over 10 years, say 20 years. They stand to lose more. Also, it is not just one time the rate would increase; this can go on over a period. Do you suggest house owners opt for a fixed-rate loan to remove risks?”

Housie said: “A floating rate loan may seem risky as it is subject to the vagaries of rate change. But it is flexible — you can switch anytime without any prepayment penalty. In fact, a fixed-rate loan may be riskier — it is not easy, even for economists, to predict the overall direction of interest rate over a longer period, and rates may go down. At that point, if you wish to switch, there are prepayment charges to pay.”

“For the sake of argument, assume that rates increase every year. Sure, you are paying higher interest. But think about the reasons why rates would increase — possibly because inflation is high. In that case, if you did not own a home, your rents will go up.

“And your salary will hopefully increase to keep up with inflation,” Rosie argued.

Lowering outgo

“You can still maintain the same total interest payment over the loan tenure, even if rates rise,” Rosie said.

“One, you can adjust the loan tenure to be shorter and pay more per month.

“For example, at 9.15 per cent, if you reduce the tenure to nine years, you save ₹1.3 lakh in interest payment through the life of the loan; your EMI increases to ₹68,113 per month. Two, you can prepay some amount to lower your outstanding balance. You can then chose to either reduce the loan tenure or the monthly EMI amount.”

Housie added: “Three, you can shop around and find another lender who gives your lower rate of interest.”

“No, that may not always be a good idea,” Lousie objected. “Even though there is no prepayment charge for a floating rate loan, there are other costs involved — for legal and technical assessment of the property, and an administration fee. You need to factor those to decide if it is worth switching.”

For once, Rosie concurred.

“You are right. For example, HDFC charges a processing fee of up to 0.5 per cent of the loan amount or ₹3,000, whichever is higher.

“Remember that you must pay the transfer cost now, while the savings would potentially be spread over many years. And the new lender may increase the rates, undoing your calculation.”

The writer is co-founder, RaNa Investment Advisors.

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