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Rising Rates: Prepay Your Home Loan or Pay a High EMI


In the current rate hike cycle, the third since May 4, the Reserve Bank of India has raised the repo rate by 140 basis points to 5.4%. All existing and new variable rate mortgage borrowers have to pay higher interest as banks immediately raise their lending rates. The impact will be greater for recent borrowers.

Borrowers, especially those with a long-term home loan, should start repaying or increasing their EMI or even consider a balance transfer to reduce their interest burden. However, many new borrowers will need to increase their tenure as they may not have the money to repay as they would have stretched their finances to pay the margin money to buy their dream home.

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Higher payouts
With the increase of 140 basis points in the repo rate, assuming the mortgage rate to increase from 7% to 8.4%, the EMI for a loan of Rs 50 lakh for a term of 20 years (new loan ) will increase from Rs 38,765 to Rs 43,075. The total interest payable will increase from Rs 43 lakh to Rs 53 lakh over the entire period. If a borrower opts for an increase in the term, it will go from 240 months to 334 months, a big increase of 94 months.

New borrowers should be careful as they have borrowed at low rates of 6.5-7.5% over the past two years. The terms of their loans can increase significantly as interest rates rise. In variable rate loans, the EMI remains constant and it is normally the term that adjusts to the rate change.

Adhil Shetty, CEO of Bankbazaar.com, says the question borrowers may be asking now is whether their mortgage rate is too high. “One of the ways you as a borrower can assess this is to check the premium you are paying above the repo rate. If you are a primary borrower (credit score over 750, stable income, on-time loan repayments), you can get home loan deals at a premium of 250-275 basis points over the repo rate. So based on the rates we’ve seen over the past few months, the lowest rate you can get a home loan at right now may be between 7.9 and 8.15,” he says.

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The range may be lower or higher depending on the borrower’s credit profile and history and the bank’s lending policy. “If you are already in this zone, you can focus on pre-paying and paying a higher EMI voluntarily to control your growing interest. If you are beyond this comfort zone, you can also consider refinancing with your own lender or with another that offers you better terms,” Shetty explains.

Existing borrowers don’t have to wait years to accumulate a large amount to prepay. Instead, they should start prepaying after maintaining sufficient cash for any emergency needs. Borrowers with limited cash can opt for the home saver option in which an overdraft account is opened where he can park his surplus and withdraw from it according to his financial needs.

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