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Making sense of higher interest rate regime

Those were the days. Or, were they? Looking back five years when banks were flush with funds and zooming in on July 2008 reveal wholly different terrains.

One had the rainbow on its horizon beckoning young men and women to invest in a house of their own. It was a time when some analysts wrote off what used to be traditionally called the loan sharks.

Then again in those days builders went gaga over the falling age of people owning a home. In Kerala, they said, home owners till then were in the 50-year-old category and now even 35-year-olds were owning homes, and palatial ones at that.

The other terrain looks clouded, threatening aspiring house-owners with a further squeeze in the money market, ripple effects of the U.S. sub-prime crisis and continuing waves of the oil shock.

The situation is not likely to ease over the short term. Over the next six months to one year, do not expect the interest rates to come down. But it is not going to create a crisis as has happened in the U.S. market, says V.A. Joseph, Chairman of the Thrissur-based South Indian Bank.

In the summer of 2003, one took a housing loan of Rs. 10.9 lakh, repayable over a period of 20 years, at an interest of 7.25 per cent. The equated monthly instalment was Rs. 9,000. The interest rate on the loan has now gone up to 13 per cent in 2008 with the instalment going up to Rs. 12,000 plus. An individual example of the rising burden of rising housing loan rates.

In general, the interest rate on housing loans has gone up significantly over the past five years, changes over the first two years being more gradual. From around 7.5 per cent, the rates have gone up to less than 10 per cent and from there, it has gone up to more than 12.5 per cent (depending on repayment duration and quantum of the loan), with the latest rates coming into effect on July 1.

Most of the banks have raised their interest rates between 0.25 per cent and 0.5 per cent with effect from July 1. The rise in interest rates, again, depends on the tenure of the loan and the amounts borrowed. On a positive note, banks have been quick to realise the burden imposed on those who have taken home loans. They have extended the repayment period by at least two years. But those who do not have the grace period will bear the additional burden less lightly.

The current rise in interest rate on home loans is a reflection of the market realities. The spiralling inflation rate is one factor that is making banks less sure of the terrain they appeared to negotiate so easily five years ago. Inflation has it fallouts in banking terms.

One is a more cautious approach to money. The Reserve Bank of India has issued a directive to banks to increase their cash reserve ratio. With it, the squeeze will grow in the money market. Banks will be forced to pay higher interests on deposits and charge higher interest on loans, including housing loans.

While the trend is in keeping with the inflationary trends in the market, including in the property market, there are questions being raised about the role of the government in keeping things under control.

Property prices have zoomed in an unprecedented manner over the past two years in the country. Kerala has been no exception in this.

Price of property in prime commercial localities on Marine Drive and Mahatma Gandhi Road and residential areas such as Kakkanad in Kochi have more than trebled over the period. The starting price of a two-bedroom flat on the outskirts of the city has gone up to Rs. 25 lakh, while a three-bed-room flat was available near the city for the same price two years ago. Those who seek to build a house on their own on a small plot of land may find even harder to digest the land prices. The rise in property prices has been more pronounced in Kochi where land has become a scarce commodity and today it looks out of reach for a salaried person.

While there has been accusations of the building industry fanning the inflationary trends by jacking up prices, the industry has been straddled with higher costs of land, materials and labour charges.

Therefore, it is time for a correction in the housing market, said a building industry observer in the city. The rising interest rate on home loans is expected to speed up this process of correction, he said, adding that investors, especially non-resident Indians, appeared to be thinking twice before making investments of over certain limits. This can slowdown the industry a bit. However, building industry sources foresee no cause for panic.

Dr. Joseph said the overall parameters of the Indian economy had been good. The growth in different sectors had been quite robust to create a balance in the system.

A crisis-like situation can be ruled out for other reasons too. For example, there was a time when interest rates hovered above 15 per cent about a decade ago. The rates gradually came down and borrowers have been accustomed to a certain level of interest rates in the market.

However, India is a global economy and several countries have already touched double-digit inflation. India cannot be insulated from these developments, Dr. Joseph said.

He felt that the boom in the job market and the rising salary levels would be able to balance the fallout of any higher interest rates. Industry observers have pointed to a tendency among some who have taken a loan to raise resources (drawing from even the Provident Fund) to repay at least a part of the loan in lumpsum.

Before this is done, one should take a look at the tax savings brought by the housing loan. Income-tax savings is still a major attraction for those who take home loans. Earnings from the assets that are planned to be used for a repayment should be considered before any decision is taken on the matter.

Investors still tend to be lured by the appreciation in the value of the property they buy at any point in time.

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