Those who opt for floating home loan rates in India always run the risk of encountering an increased rate at any point. There can be various factors that may lead to unfavourable interest rate hikes. An increase in the repo rate will lead to an elevated Marginal Cost of fund based Lending Rate which eventually increases the lending rates.
To understand how one can deal with the rate hikes, one must first have a grasp of these financial factors.
Interest Rate Hikes Due To MCLR
In its simplest definition, MCLR is the minimum rate at which financial institutions can lend funds in the form of loans to the borrower. MCLR is determined based on the repo rate announced periodically by the Reserve Bank of India.
A hike in this rate is one of the fundamental reasons behind any increase in floating housing loan interest rates for all loans linked to MCLR.
Take the recent hike in floating rates, for example. It came weeks after RBI increased the repo rate by 25 basis points twice in consecutive months. In absolute terms, they increased it from 6% to 6.5%. Immediately after that, most financial institutions increased their interest rate by 0.1%.
While a 0.1% hike may not seem much, although it adds up to a substantial amount when compounded for several years as a home loan is a long term commitment. You may not even notice it as most lenders increase the tenor and not the EMI amount.
How to Tackle Interest Rate Hikes?
There are specific steps that you can take to dampen the adverse effects of interest hike on your home loan.
- Loan Refinancing
Switching your lender may be of help if the increased interest rates
lead to EMIs beyond your comfort. There is no uniformity in the increase of interest rate when the repo rate goes up. Some lenders may increase more than the corresponding rise in repo rate basis points.
For example, while the 0.1% hike was standard across most lenders, some increased the rate of interest by 0.25%.
If your lender increases it more than the standard policy, it might be prudent to switch to a different lender. The provision for this is available with the home loan balance transfer facility. An increase in interest rates is one of the times when you should opt for home loan balance transfer. Do note that most NBFCs offer this service after a minimum of 18 months of EMI payment.
Part-prepaying your housing loan is a practical way to reduce the amount you pay as EMIs. As you pre-pay a certain percentage of the loan, your tenor or the EMI comes down immediately. Eventually, it reduces the total interest you pay for the whole loan.
- Increase the EMI, Not Your Tenor
As mentioned earlier, most lenders simply increase the tenor post a hike so that there is no immediate effect on the borrower. However, since home loan interest rates are compounded in nature, even 0.1% hike will accrue a substantial amount as the total payable interest.
So, ask your lender to increase the EMI amount, instead of the tenor. You may calculate the revised EMI amount using a home loan calculator. While the pocket pinch shall be a bit higher initially, you will save a substantial amount in the long run.
- Tax Benefits on Home Loans
You can also tackle the additional expenses due to interest rate hikes via tax benefits. As per Section 80C of the Income Tax Act, you can avail tax deductions of up to Rs. 1.5 Lakh per year on interests paid towards your home loan. If the interest rates are raised, you can save more tax on the total interest paid provided as per the exemption.
However, you can enjoy these home loan interest tax benefits even after you transfer your home loan to another lender.
A hike in the interest rate may prove to be a substantial burden for any borrower. Use these tactics to reduce the burden to some extent. You can even optionally refer to loans with fixed interest rates to avoid paying additional interests even if it increases. However, note that the rates will not reduce either once it is fixed for the full repayment tenor.