Monetary Policy: EMIs all set to go up

Home loan borrowers will be more hurt as they have to pay higher interest
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Representational Image Pxhere [Creative Commons]

Our social set-up has undergone a sea change. In fact, it continues to gladly fall in line with the changing times.

Whatever the nature of changes taking place around us, there is a common force which drives these changes to the grass root level.

This common force has its might in finances. In other words, finance is the lone element fueling today’s social change; of course, for betterment.

So, availability of finance in the modern times holds the key to witnessing the living standard of societies getting modernized. But when it comes to availability of finance, the resources for larger parts of the societies were scarce till banks and financial institutions liberalized lending policies.

This paved the way for almost all segments of populations to avail loan facilities irrespective of their economic status. Today, even for ordinary persons buying anything on a loan has made their life easy.

Precisely, living on a bank loan or more precisely on equated monthly installments (EMIs) has become a priority for almost all families if not every individual.

The kind of fast growing consumerism coupled with an emerging sea of personal needs has forced almost all segments of populations, especially the young generation to live their life on EMI.

Precisely, loans have now been shaping the way of life to realize growing aspirations as everything is available on EMI. Now people think EMI, eat EMI and breathe EMI. However, affording a loan is different from EMI affordability. You may be able to afford an EMI for a few months or some years but not the actual Loan. For paying an EMI on a long term basis, you are ignoring future needs.

You may consider an increase in your future income, but then inflation will also rise and there would be other added expenses simply adding to your financial burden. One more thing is that you may afford higher EMI today, but this way you would be having lesser chances of saving for your future.

Needless to mention that over a period of time you would be loaded with more responsibilities in life and to shoulder them savings for the future is inevitable. You must understand that when you purchase something on EMI, it may be for immediate gains, but at the end you pay for a period of prolonged pain.

These EMIs, of course, help you to have goods that you might not have been able to otherwise afford - from kitchen appliances and washing machines, to luxurious cars and high-end electronic gadgets, including smartphones, tablets and LED TVs, etc.

But these consumer goods are essentially depreciating assets and you are paying more for something that is fast losing its value, and paying more for it over the long run.

Now you must be thinking why EMIs became the subject of discussion today. The reason behind is that the interest rates on loans are going up after the Reserve Bank of India (RBI) announced the repo rate - short term lending rate – hike by 50 basis points in its monetary policy announced on Friday, August 5.

What is the exact hike in rate of interest announced by the RBI?

The Reserve Bank of India (RBI) in its August 2022 Monetary Policy hiked the repo rate by 50 bps to 5.40 per cent. It’s the third consecutive rate hike in 2022.

This is the third repo rate hike in this financial year, starting with the unscheduled revision of 40 bps (one basis point is 0.01 percentage point) in May 2022. So far, this short-term key lending rate has witnessed 140 bps hikes since May 2022.

It’s worth mentioning that the repo rate is now above the pre-pandemic level, which was 5.15%. During the peak Covid times, the RBI slashed the repo rate to 4% at different stages.

Why did the RBI hike the repo rate?

The RBI raised the key policy rate in a bid to tame the spiraling inflation. The retail inflation has remained above 7% for the last three months but has eased from an eight-year high of 7.79%, witnessed in April.

Notably, the core inflation has already breached the Reserve Bank’s targeted range of 2%-6%. Meanwhile, the Monetary Policy review has dished out inflation forecast for remaining three quarters of the current financial year at 7.1 per cent for period between July – September (Q2); at 6.4 per cent, for period between October – December (Q3); and at 5.8 per cent for the last quarter Q4 (January to March 2023). Even the inflation forecast has been pegged at 5 per cent for the first quarter Q1 of the next financial year 2023-24.

What is the impact of this rate hike on borrowers?

The movement in the repo rate decides the cost of loans (in terms of rate of interest) for the borrowers.

As the repo rate stand hiked by 140bps and crossed the pre-pandemic level, popular retail loans like housing loans, car loans, personal consumption loans, business loans etc. will be now more expensive.

The equated monthly installments (EMIs) of the existing borrowers will go up and they will have to shell out more to fall in line with the revised rate of interest. The impact will be equally on the new borrowers as the cost of loan will shoot up.

It’s worth mentioning that all floating loans in the retail segment sanctioned by banks after October 1, 2019 are linked to an external benchmark.

In most cases the external benchmark is the repo rate. This means that the latest hike in repo rate will be fully passed on to the borrowers and banks must be busy in calculating the percentage of interest to be increased. Notably, the hike will be worse for the home loan borrowers.

They will have to bear the interest burden for longer periods, as their loans carry long-term repayment schedules. Here some examples of rate hike impact quoted by the Moneycontrol are worth reproducing.

“A home loan borrower with a current interest rate of 7.4 percent, outstanding principal of Rs 30 lakh and tenure of 20 years could see his/her tenure being extended by over 24 months.”

Larger loans will entail higher interest payouts. For instance, the revised repayment period for a Rs 1-crore home loan with an interest rate of 7.5 percent and original tenure of 20 years (240 months) will be over 22 years (265 months).

This means that the interest payout over this period will rise by close to Rs 20 lakh. If the EMIs are increased instead, the borrower will have to shell Rs 3,085 more every month. The overall increase in interest burden will be Rs 7.4 lakh,” mentions the Moneycontrol in its report quoting Vipul Patel, Founder, MortgageWorld, a loan consultancy firm.

What is the way forward in the rising interest rate scenario?

While opting for loans, it is always necessary to look beyond the initial years and calculate the potential impact that EMI payments will have on your future financial life. It is just a matter of good financial planning.

Ensure total EMI of your loans remains below 40 percent of your take home salary. Examples galore which suggest that anything outside this range puts a borrower into a debt trap. Don’t get lured to small/affordable EMIs.

Always remember that your monthly budget and cash flow position is always changeable under the circumstances of repaying a bank loan.

Check your net income (inflow) and expenditure (outflow) and the difference between the two will give you the quantum of your cash reserve.

This cash reserve figure is the actual empowerment you possess to decide the amount of loan you can obtain and repay without any default.

Precisely, the power of a bank loan has two sides. It can either bring prosperity to you or leave you in a debt trap.

Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.

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