What to do with the home loan
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If high EMIs are bothering you, periodic prepayment may be of help. BIJU GOVIND checks out the various options.
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Inflation has struck everyone. The worst hit is the middle class. Panic and depression have gripped home-loan borrowers particularly.
The decision of the Reserve Bank of India (RBI) to combat inflation by way of increasing the Cash Reserve Ratio and Repo rates has resulted in some banks raising the benchmark prime lending rate by 50 to 75 basis points. The Repo rate is the rate at w
hich the RBI gives short-term money to banks in exchange of government securities, while the Cash Reserve Ratio is the mandatory amount the banks have to deposit with the RBI.
Home-loan borrowers thus are faced with an increase in their equated monthly instalment (EMI). Some banks have already asked customers to pay the additional amount as a single sum towards the end of the financial year. Others have increased the loan term.
The EMI is calculated based on the interest rate, loan amount and term. The EMI for a Rs. 1 lakh loan at 11 per cent interest for 20 years is Rs 1,032. It goes up to Rs. 10,320 for a Rs. 10-lakh loan.
If the interest rate is increased to 11.5 per cent, the EMI will be Rs. 10,664. If the increase is to 11.75 per cent, the sum will be Rs. 10,838. Time was when the housing loan rates stood at 7, 7.5, 8 and 8.5 per cent and banks competed with one another to bring them down to woo customers.
No relief
Almost all nationalised and commercial banks have said that the rates are unlikely to climb down in six to eight months. Bankers say that inflation will remain high throughout the year and is expected to cool off only in 2009.
Home-loan borrowers need know that EMI has two parts — the principal and interest components. The principal component is the cost of the asset bought on the loan, while the interest is the expense incurred to get the asset. Any hike in interest rates means a borrower will have to remit an extra amount every month.
Incidentally, the money that goes into the interest component will be higher. The increase in interest rates increases the interest component.
So what are the options before borrowers to beat the inflation? One of them is to prepay the loans. Another is periodic prepayment. However, borrowers will have to check if banks penalise them for prepayments and see the clauses attached to pre-closure.
Public sector banks such as the State Bank of India (SBI) charge no penalty if the loan is pre-closed from own savings or windfall gains, for which documentary evidence is produced by the customer. However, in case the borrower does not produce such proof, a penalty at the rate of two per cent on the amount prepaid in excess of normal EMI dues shall be levied if the loan is pre-closed within three years from the date of commencement of repayment.
Reduced interest
Financial consultants say that periodic prepayment will help to reduce the loan tenure as well as bring down the interest rates. A borrower can repay in instalments ranging from Rs. 5,000 to Rs. 10,000 or Rs. 10,000 to Rs. 50,000 depending on the loan amount and tenure. This can diminish the EMI and thereby reduce the interest expenditure.
Prepayment can be done in several ways. Those having fixed deposits in banks and post-office accounts can utilise the money to repay the loan. Fixed deposits and post-office accounts remain idle. Utilise them. It is better to repay a loan amount having an interest of 11.75 per cent rather than getting an interest on the amount at the rate of 9.5 per cent.
Another method is to dilute part of investments in gold since the prices of yellow metal have maintained an upswing. Money invested in stock markets can also been used to prepay loans. However, one should see if the stocks have plummeted to lows. Besides, the investor should have made profits ranging from 50 per cent to 75 per cent at least. Stocks of blue-chip companies, if they had been bought a few years ago, have not recorded their 52-week lows.
New home-loan borrowers should try to keep the loan amount low. Avoid taking additional loans for maintenance of existing houses.
The interest the borrower will be paying will be comparatively high now. Apart from that, new housing projects are going to experience a cost escalation.
Most of the banks have already hiked interest rates and may do so further if inflation is not contained in the coming months.
Experts say that runway inflation that has been triggered by rising crude oil prices will continue this year. Crude oil prices might even touch $175 a barrel, if we are to believe the leaders of the Oil Producing and Exporting Countries.
In April, a barrel cost just $64 and now it has crossed $143. The depreciation of the rupee has also contributed to the rising inflation.
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