Gaurav Mohta lists three ways to ensure a smooth financial situation for your family despite rising interest rates.
After two years of favourable interest rates and the RBI's 'accommodative' approach, we have seen a recent hike in the repo rate by 40 basis points (100 basis points = one per cent). However, for the affordable home finance industry the effects are bound to be felt in a much muted manner.
We are confident of a steady demand for housing units in the affordable segment due to these two factors:
- It's a genuine end-user generated demand
- Gradual hike in the rate, smaller loans, hardly bring any change to EMI
Let me try and explain this a bit. The rate hikes expected for this segment are gradual and in single digits for the foreseeable future. With the loan amount in this segment being roughly around Rs 10-15 lakh on an average, even an interest rate hike by 50 basis points is likely to only increase the EMI up to Rs 500-Rs 750 per month.
Also, post pandemic there had been some pent up demand driving demand. The festive seasons have also done fairly well and we expect the same momentum to continue.
Nonetheless, with rising costs and general inflation in the economy, managing your home loan can be very instrumental to your overall expenditure in the coming months or even years.
There are three ways in which you can ensure a smooth financial situation for your family despite the rising interest rates. While two of them involve slight changes in your current home buying framework, the third one can not only act as superpower to help you navigate high interest rates but also help save a large amount on the interest outflow:
1. Opt for a smaller loan: Let's say you are comfortable paying an EMI of Rs 15,000 but choose a loan amount which incurs a lesser EMI, like say Rs 12,000.
Keeping a buffer, especially for the affordable housing customers is very important. Probably a little increase in your down payment amount will offset this.
2. Choose your space smartly: For customers who are yet to finalise their property or plot size, be smart. Choose what you need and not what you aspire for! This could help in keeping both your financial obligations and your blood pressure under control.
You can always upgrade when you are more comfortable and financially stable.
3. Manage your overall interest outflow: Rate hike means you pay higher interests. The easiest way to counter this is prepayments. Prepayments can help reduce not only the overall interest outflow, but also the tenure of the loan.
A payment made over and above the regular EMI, gets deducted directly from the principal amount borrowed. Meaning, the next EMI you pay will be calculated on a reduced principal amount and this is why prepayment becomes your superpower.
Now, based on your financial stability, you can either choose to make the prepayments as per your situation every month or you could choose to use your superpower -- small, regular, automated prepayments, or auto prepay, as small as Rs 500 per month.
Auto prepay acts as a standing instruction that deducts a predetermined amount of money from your bank account towards your home loan prepayment on a fixed date every month.
Being a free voluntary service, not only are you able to make regular prepayments without any extra charge but you can also choose to cancel this service due to any unfortunate emergency.
Let me show you how this works:
Rohit has taken a loan of Rs 2,500,000 (Rs 25 lakh) at 10 per cent rate of interest for 20 years. The formula for calculating EMI is P × r × (1 + r)n/((1 + r)n – 1). Using this we get the EMI for Rohit as Rs 24,126.
As he pays his first EMI, only Rs 3,292 goes towards paying off the total principal amount due and the remaining Rs 20,833 goes as interest paid.
As the months go by, though the EMI remains the same, within it the interest component decreases as you repay more and more of your principal.
For Rohit in our example, in the next months the amounts of Rs 3,292 and Rs 20,833 will become Rs 3,320 and Rs 20,806... Rs 3,347 and Rs 20,778 and Rs 3,375 and Rs 20,750 and so on till the end of 240 months (20 years).
However, if he chooses to make a prepayment of Rs 2,000 every month, he will be able to close his loan in 193 months, saving him 47 months of EMIs and Rs 7,63,612 in interest payments.
You can also observe this amortisation table below for detailed reference:
Gaurav Mohta is chief marketing officer, HomeFirst Finance.