There has been a sharp rise in the interest rates faced by Indian borrowers in the last year and the impact has been felt especially by those who have long tenure loans.
Housing loans are the biggest component of long tenure loans and most of these have been taken on a floating rate basis, which means that they are feeling the impact of the change.
Considering the exact situation, it is vital to know what are the options before the borrowers so that they can meet up to the challenge that has cropped up.
Rise In Tenure
The rise in the interest rate on housing loans is seen through an impact on the remaining tenure of the loan. Most banks and institutions keep the Equated Monthly Instalment, or EMI, that the borrower has to pay the same and the tenure of the loan is extended. This means that the borrower will have to repay the loan over a longer time period at this higher rate of interest.
One of the unintended consequences of this move is that for many people the loan tenure now has become so long that it might even extend beyond their working life into retirement. This can turn out to be a problem if it is not tackled and hence, it is essential that every person has a clear strategy that they will use.
Prepay Part Of Loan
One of the ways to tackle the situation of an extended repayment time frame on the loan is to prepay a part of the total loan, so that this reduces the outstanding capital. Once the reduced amount of the loan is used for the calculation, then the period of the loan outstanding will also reduce. This will mean that if the period had gone more than what was possible to repay, then this would once again pull back the repayment period and it would come under control.
The earlier the amount is repaid in the life of the housing loan, the bigger will be the impact, so this route is more suitable for those who have a long tenure left on their loans. The financial impact of this is that a lumpsum would go towards loan repayment and this cannot be used for other investments.
Increase The EMI
The other option, which will bring the tenure of the loan once again within reasonable limits, is to increase the Equated Monthly Installment on the loan. This will lead to a higher payout that has to be made each month by the borrower. This step will require some homework and calculation because the extent to which the EMI is raised would impact the period of the loan outstanding.
The higher amount of the EMI has to be balanced with the fact that it has to be affordable because this is a continuous payment that has to be made each month. This should not create additional strain on the family finances some time down the line and hence, this needs to be taken into consideration when the new EMI is fixed.
Do Nothing
There is also the third option, which is to do nothing. There is a logic behind this move too because the thinking behind such a strategy is that the housing loan is a long-term loan. Over a period of time, the entire interest rate cycle will play itself out. Thus, when inflation cools in the economy, the rate will start coming down and this will reduce the outstanding loan tenure.
The rise in the period that is being seen now is not permanent but can prove to be temporary because the falling interest rates will once again bring the tenure down. This will work when the rates actually come down but if they don’t, then the borrower will have to put into play some other strategy and try and manage the situation.
Arnav Pandya is founder at Moneyeduschool.
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