Higher EMI payments after home loan interest rates hike

I believe the latest hike in home loan interest rates, while impacting the customer, will not affect the overall home loan market.

The month of May saw several institutions go in for a fresh round of interest rate hike by at least half percent. HDFC, the country's largest home finance company, increased its rates on home loans by half a percentage point across the board. The prime lending rate which serves as a benchmark for floating rates was increased to 11.75 percent from 11.25 percent earlier. The move would affect existing floating rate borrowers who would have to pay half a percentage higher. Fixed rate loans which were ranging between 9.75 to 10.75 percent, have been revised to 10.5 percent across all slabs by HDFC.

Public sector banks like State Bank of India, Punjab National Bank, Bank of Baroda and Union Bank among others have revised interest rates. The floating interest rates of most institutions are in the region of 8.75 percent to 9.75 percent while fixed interest loans are between 9.5 to 10.5 percent. Rising cost of funds, meaning rising deposit rates, have triggered the prime lending rate increase and the rise in interest rates, says SBI Deputy General Manager, Home Loans, M L Paulson.

The impact of the increased interest rates would be higher EMI payments for borrowers or longer tenure repayments. Increased EMI would affect borrowers in that for instance a home loan borrower borrowing Rs 25 lakhs for 20 years will at eight percent interest rate have to pay an EMI of Rs 20,925. At 8.25 percent it would be Rs 21,325 while at 8.5 percent it would be Rs 21,700. Thus a half percent increase would mean an increase of Rs 1,000 in the monthly EMI. The last 18 months has seen interest rates going up by 200 basis points or two percent. The impact of the hike for an existing borrower would also be an increase in the tenure of the loan by a year or two. A 20-year loan would now get repaid in 21 or 22 years with the existing EMI.

The new home loan borrower would find his eligibility reduced considerably given the rising property prices coupled with the rising interest rates. This is illustrated by an example. Most banks sanction loans on the basis of income slabs. For a Rs 30,000 monthly income, banks would consider that the person's repayment capacity is around 50 percent of his income - Rs 15,000. Considering the fact that the interest rate was at 7.25 percent in January 2005, he would have been eligible for a loan of Rs 18.99 lakhs (EMI per lakh per month at 7.25 works out to Rs 790. Thus 15000 divided by 790 multiplied by 1,00,000 is 18.99 lakhs).

Here we will know how to calculate home loan eligibility according to salary:
Now that the interest rate has increased to nine percent the same person with monthly income of Rs 30,000 would be eligible for Rs 16.67 lakh (EMI per lakh per month at nine percent works out to Rs 900. Thus, 15,000 divided by 900 multiplied by 1,00,000 is equal to Rs 16.67 lakhs). This goes on to show that in this case the eligibility has gone down by over Rs two lakhs.

Reduced eligibility would result in bringing down his aspiration levels and a borrower would find himself compromising on the location and size of his home. I think the borrower would also find it difficult to raise the margin money or his personal contribution towards the home loan. He may resort to personal loans to raise the additional finances. Parallel funding will happen in that he would take a personal loan from one bank and home loan from another. The customer would thus be overstretching and overleveraging himself.

Financial institutions have not planned and managed their funds properly and borrowers are facing the consequences. The last four months have seen increase in interest rate thrice, which is uncalled for i believe and I suggest. Buyers may adopt a wait and watch policy before undertaking purchases. The Reserve Bank's directive on increased provisioning for home loans above Rs 20 lakhs may see banks going slow in lending to this segment. Typically, banks have a lot of opportunity to lend to other growing sectors like agriculture and the services sector. They may step up lending to these sectors.

Though there could be a slight slowing down of pace by small players due to the increased provisioning requirements and higher risk weightages required by RBI, the larger and focused players will continue to grow strongly, since the principle growth drivers for this market still show strong sustenance.

Another view is that housing has been a growth story and banks would not like to suddenly reduce their commitments drastically. Though there may be a slight drop in some segments, overall there will not be much difference in cities where there is continuous demand and supply. This would more likely impact small B class cities.

If property prices have gone up, so have rentals. Hence a consumer would prefer to buy a property rather than pay exorbitant rents. The home loan market would thus be unaffected, despite the interest rate hike. The silver lining in all this is that the effective interest rate would work out to 6.75 percent to seven percent for the borrower who can get the full tax benefits on the home loan interest.