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Home Loan Interest Rates Hiked. What's Your Game Plan?

Stocks are not the only financial products that are volatile.

Even the interest rates go through periodic cycles of ups and downs.

And, if you are a home loan borrower, your personal finances could experience serious stress when the interest rates are rising.

This calls for an immediate action... to bring down the total interest outgo and / or the monthly EMI payout.

Broadly speaking, there could be three scenarios:
a. EMIs do not change: Given your age, there is a cushion to increase the tenure. So banks normally increase the loan tenure, keeping the EMI unchanged.

b. Higher EMI is not a burden: There is no leeway to increase the loan tenure. So the EMIs go up. But, your income is sufficient to absorb the revised EMI.

c. Higher EMIs are not manageable: There is no leeway to increase the loan tenure. So the EMIs go up. However, given your present income, paying higher EMIs every month is not going to be easy.

Different scenarios means different action plan.

Also, given your particular financial situation means your action plan will be different from others.

Let's see what options do we have at our disposal — and the benefits thereof.

Note: For simplicity purposes, I am assuming that we had only finalized the loan but not yet availed the same. Meanwhile, the rates have increased and we have to choose the best option to counter this rate hike. The broad plan of action will remain the same for an existing loan.

Before Rate Hike
Loan: Rs.50 lakhs
Rate of interest: 8.5%
Tenure: 20 years
EMI: Rs.43,391
Total interest outgo: Rs.54.14 lakhs

After Rate Hike - Increase in Loan Tenure
Loan: Rs.50 lakhs
Rate of interest: 8.75%
Tenure: 21 years i.e. increase by 1 year
EMI: Rs.43,391
Total interest outgo: Rs.59.53 lakhs

After Rate Hike - If EMI is increased
Loan: Rs.50 lakhs
Rate of interest: 8.75%
Tenure: 20 years
EMI: Rs.44,186 i.e. up by Rs.794
Total interest outgo: Rs.56.04 lakhs

Case 1: Increase in tenure not possible. But, higher EMIs are not manageable.
As seen above, if the banks cannot increase the loan tenure and have to perforce increase the EMI, you will have to shell out around Rs.800 extra per month. Your EMI increases from Rs.43,391 to Rs.44,186.

Since you would like to maintain the earlier EMI, the only option is to reduce the loan amount. For a new loan you will have to borrow less, and for a running loan this will mean part-prepayment.

Assuming, we target the same pre-hike EMI:
Loan: Rs.48.90 lakhs i.e. reduce the amount by Rs.1.10 lakhs
Rate of interest: 8.75%
Tenure: 19 years 10 months
EMI: Rs.43,391
Total interest outgo: Rs.54.09 lakhs

Thus, a small prepayment of Rs.1.10 lakhs will bring down the EMI to the levels before rate hike.

In other words, in this scenario you have to simply borrow less / part-prepay to avoid the adverse impact of a rate hike.

home-loan-rate-hike
Has your home loan become a burden due to hike in interest rates?

Case 2: Increase in tenure not possible. But, you can afford the higher EMIs.
Your income levels are good enough to pay the extra Rs.800 per month as EMI. So the rate hike does not bother you much.

If that be so, you will probably not be stressed. You would simply learn to live with the higher EMI burden.

However:

Apart from EMI, the rate hike also increases the total interest outgo by almost Rs.2 lakhs — from Rs.54.14 lakhs to Rs.56.04 lakhs.

Since it is always prudent to pay lesser interest, you should endeavour to bring down the total interest outgo by reducing the loan amount.

As we have seen in Case 1, by prepaying Rs.1.10 lakhs the total interest outgo is down to Rs.54.09 lakhs, which is almost the same as pre-hike total interest outflow of Rs.54.14 lakhs.

As an added benefit, the EMI is back to the pre rate-hike levels and the tenure is down by around 2 months.

[Alternatively, instead of part-prepayment, you can opt for even higher EMI than the revised EMI, if that option is more suited to your monthly income flows.]

Case 3: The loan tenure is increased.
Let's say the banks do not change the EMI, but increase the loan tenure. Then, the total interest outgo jumps up by about Rs.5.40 lakhs (= Rs.59.53 lakhs - Rs.54.14 lakhs).

This is a big setback and needs to be corrected.

If your monthly incomes are comfortable, you should opt to pay higher EMIs instead of increasing the loan tenure.

Assuming, we target the same pre-hike total interest outgo:
Loan: Rs.50 lakhs
Rate of interest: 8.75%
Tenure: 19 years 5 months
EMI: Rs.44,680 i.e. up by Rs.1288 
Total interest outgo: Rs.54.10 lakhs

Thus, by paying around Rs.1300 extra per month you can save Rs.5.40 lakhs extra interest outgo due to rate hike.

[Alternatively, instead of higher EMI, you can opt for part-prepayment, if that option is more suited to your net worth. Read Step Up Your Loan EMIs For Mind-Boggling Savings]

Needless to mention, you can also use a combination of the above strategies.

For example, you can partly prepay and partly increase your EMI. Or, you can switch to the new lender offering lower rate of interest, while at the same time bringing down the loan amount.

In short, there are multiple strategies to tackle the threat of rising home loan interest rates on your personal finances. You have to choose the most appropriate plan of action and protect your finances from excessive damage.

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