How do you manage your Home Loan EMI and tenure with rising interest rates?

Rashid, who just turned 45 years, did not own a house for a long time. The trigger came when property prices fell sharply in Bengaluru with the onslaught of Covid.

Additionally, interest rates on home loans also hit a multi-decade low of 6.5% p.a. He finally took the plunge in Mar ’21 and bought a new house with a one crore home loan of 15 years; its EMI worked out to Rs 87,111. He calculated that by the time he turns 58 years (nearing his retirement age), his home loan liability would be over.

However, he was caught off-guard by the interest rate trends. His lender hiked interest rates six times in two years, eventually bringing the home loan rates to 9%. With most of the home loans linked to Repo rates, it went up when RBI hiked them to combat inflation in the economy.

The net result – his 15-year loan has now become a 20-year loan, despite two years of prompt EMI payment. His biggest worry is that his loan repayment would also extend into his retirement years. But, with home loan interest rates moving up sharply in a short period, people like Rashid are in a significant financial fix.

Here are some strategies to cope with finances in this high-interest rate regime:

Negotiate

This is the best time to negotiate the interest rates with your existing lender. There have been instances of lenders reducing interest rates by 0.5%. Improve your credit score to make a better case for a lower interest rate.

If the existing lenders are not budging, opt for refinancing with a new borrower. Thanks to intense competition, lenders are ready to sacrifice some of their margins to get new customers. Even a 0.75% reduction in the interest rate for Rashid could mean his EMI reduced from Rs 1,00,582 to Rs 96,589 while keeping the loan tenure intact.

Some lenders offer low rates, especially for women, while others keep rates below 9%. Do the necessary due diligence on the costs and the lender’s reputation before refinancing.

Make prepayments

One might be tempted to dip into the retirement kitty to prepay home loans. Don’t do that, as it could compromise your retirement goals. However, if you have money lying idle in your bank account or have some random investments earning low yields, put it to good use.

Make part prepayments on your loan, ultimately reducing your interest rates. In the initial years of loan repayment, a significant part of the EMI goes towards paying the interest on the loan.

In the above example, in the first year, about 61% of the overall EMI payment of Rashid goes towards interest payment, while the rest goes towards principal repayment. In the eighth year, the extent of the interest component of EMI falls to 39% (see chart). Any prepayment made in the early years can substantially reduce your overall interest payments.

For instance, if Rashid prepays Rs 10 lakh of the home loan, his EMI will reduce from Rs 1,00,582 to Rs 89,685. In the process, he will also save about Rs 7 lakh in interest repayment.

Don’t let it go beyond retirement age!

If the EMI payments are crossing into the retirement age (say 60 years), one should consider strategies to reduce the tenure. For instance, Rashid could opt for a higher EMI to maintain the loan tenure. Instead of paying an EMI of Rs 87,111, he could pay an EMI of Rs 1,00,582 so that his loan gets fully repaid before turning 58.

Stretching EMI payments into the retirement age could otherwise compromise financial independence and retirement lifestyle. As a thumb rule, also do not opt for a loan tenure beyond 15 years. Beyond that, interest liabilities shoot up without offering commensurate benefits in the form of lower EMI.

Floating or Fixed rate

If you transfer a loan to a new player, should you opt for a fixed or floating-rate home loan?

While the conservative lot might be tempted to opt for a fixed loan to reduce the risk of a further escalation in interest rates, RBI also seems unlikely to make significant rate hikes (given concerns over its effect on economic growth) from hereon.

Any fall in interest rates would also benefit the floating-rate home loan borrowers immensely. So, consider floating interest rates if you have sufficient cushioning to weather the uncertainties. However, if you are already at the rope’s end, play it safe.

Some lenders offer flexi loans whereby you first pay interest-only EMIs (say in the first four years) and higher EMIs later. However, while it gives instant gratification, it ultimately adds to your financial burden later in the form of higher interest-rate payments.

Supposing Rashid opts for flexi loans whereby the bank offers a 4-year option to pay interest-only EMIs. His EMI will reduce to Rs 69,361 in the initial four years. 

However, after that, EMI will rise to Rs 1,24,500. So unless you are confident of a high income in the future or expecting a significant cash flow, do not opt for such products.

Takeaway

Negotiate, refinance and prepay to reduce the EMI burden. Also, do not dip into a retirement fund or let the home loan liability extend beyond your retirement age.