The Reserve Bank of India (RBI) has hiked the repo rate by 190 basis points (bps) to 5.9% so far this year, taking interest rates to slightly above the pre-Covid levels. The repo rate is the rate at which commercial banks borrow money from the RBI to meet their short-term fund requirements. Thus, with the cost of borrowing rising for banks, most banking entities have passed on close to 50 bps to 80 bps of the rate hikes to customers across product lines.
In its monetary policy statement, RBI said it had decided to raise its key interest rates to contain inflationary pressures and maintain macroeconomic stability. The rate hike was in line with keeping the growth momentum in FY23 at 7%, from an earlier forecast of 7.2%, and not causing a significant slowdown in investment demand or employment generation. This is so despite projecting that inflation will likely remain above the upper tolerance band of 6.7% for 2022-23.
How Banks Have Responded To Repo Rate Hikes
The Covid-19 pandemic lowered the demand for home loans due to people focusing more on their essential needs and having less disposable income to cover their equated monthly installments (EMIs). Those who already had running loans were given a moratorium to cool pressure off. But as the economy recovered post the peak pandemic times, a low-interest rate regime boosted home affordability and rekindled housing loan demand.
But since May, most lending institutions quickly increased their marginal cost of funds-based lending rate (MCLR) to make up for their lost revenues. The housing finance companies (HFCs), increased their prime lending rate (PLR). The net effect for the borrower is higher rates and the need to brace for more hikes in the coming few months given the rising interest rate trajectory globally and elevated inflation driven by geopolitical stress.
As a result, all lenders, including home loan providers who borrow funds from the central bank or other banks or debt market borrowing in the case of NBFCs/HFCs regularly, are expected to hike their lending rates in line with the upward movement in cost.
Higher rates by 100 bps to 150 bps are unlikely to adversely impact the home buyer’s sentiment, particularly in the small ticket segment.
A hike in rates beyond 150 bps will likely lead to softening in demand from new borrowers. Having said that, it is yet to be seen how the home buyer’s outlook has evolved through the pandemic. Most of us know that consumer preferences have changed significantly across industries due to COVID-19, and a similar trend has also been observed in real estate.
Homeownership is at the top of Indians’ priority list, and housing demand has shifted from compact homes in metro areas to larger homes in the periphery. Thus despite higher interest rates, the demand for housing from small homeowners is likely to remain robust.
How Consumers Have Responded To Repo Rate Hikes
There is no standard impact on borrowers in the real estate industry as the influencing factors of an interest rate hike differ for different categories.
While small-ticket borrowers are less impacted by rate hikes, this might spell trouble for those who have taken large loans and opted for floating interest rates on their loans. There is undoubtedly a specific reason for the immediate impact on borrowers with a floating rate, as it is mandated to be linked to a benchmark such as the repo rate. And the subsequent effect on repo rate linked lending rate (RLLR), such as the floating rate, is seen within a quarter of the change in the benchmark.
Investment home buyers tend to opt for higher loan amounts when compared with self-occupied home buyers and affordable home buyers. This is because they plan to use these properties as an investment vehicle or even rent them out if there is no scope of selling them off at higher prices in the future.
Since investment home buyers have a higher loan amount, they are naturally more impacted by rate hikes in a floating interest option. As a result, they will have to pay more on the interest component of their loans as the lenders increase the interest rates triggered by RBI’s repo rate hike.
As is clear from the explanation of rate differentials, the self-occupied affordable home buyer with a lower loan amount is less likely to be impacted by the rate hike.
What Should Consumers Do When Taking A Home Loan?
Fixed Rate Home Loans
Fixed rate home loan borrowers are not impacted by interest rate hikes as the current interest rates are locked in for a part or whole of the tenure of their loans. Therefore, if you have taken a fixed-rate loan, there will be no impact on your monthly EMIs or repayment amount for now.
As the borrowing rates have increased, so have the deposit rates. So, the smarter ones who opted for a fixed interest rate option for certainty have been successful in averting the risk now. They can try to save some and earn better from those savings to cope with the continued inflationary pressure.
Affordable Home Loans
Now there are two notions in the context of rates opted for by affordable home buyers.
Some small ticket borrowers with meager disposable income and less awareness about the financial markets tend to pounce upon the opportunity of a low-interest rate. Such borrowers benefit in the short term from low interest in a floating option. But the rate hike by RBI, as seen recently, directly and adversely impacts their financial stability as they pay much more interest after the move.
This results from the fact that the lenders quickly react to increased repo rates by increasing their MCLR/PLR.
Those borrowers who have a better understanding of how the markets function and have the leisure of disposable incomes tend to opt for fixed-rate loans over floating ones. This is even though the interest rates in the fixed option are higher than the contemporary floating rate in a low-interest rate regime.
The logic owes to their lower appetite for risk associated with fluctuating interest rates over periods ranging from one year up to five years, depending upon individual requirements and the financial standing of applicants. The rates may vary according to prevailing market conditions when taking out mortgages on their properties. But there is still certainty in fixed interest rates, and the borrowers can effectively budget their future payments accordingly.
Floating Rate Home Loans
The downside of a floating rate option is that they make the loans unnecessarily bulky at a later stage when the borrower pays way more interest than the principal repayment. Assuming that most floating rate borrowers constitute the more vulnerable section of society, we can conclude that they are in a position where they cannot bear the brunt of increased rates.
Bottom Line
As per RBI data, home loans constitute around 65% of all outstanding bank loans in the country. Most of these borrowers opt for floating rate loans which are affected by interest rate hikes. Irrespective of the category in which a borrower falls, the ideal approach to prevent defaulting on a loan is to budget the expenses well in advance. The planning involves things such as:
- Vetting the interest rate options;
- Optimising other expenses to make room for uncertainties (such as rate hikes);
- Ensuring a safety net (such as an emergency fund with disciplined savings in a safe avenue); and
- On top of all, paying off the loans as soon as possible through staying ahead of schedule.
The era of low-interest rates seems to be over and thus better financial planning for one’s future will ensure he/she has a limited impact on the rising interest rates. The silver lining is you will own an asset which will also appreciate.
