The chances of a further reduction in rates are very low. However, home borrowers should not ignore the possibility of rates rising from current levels. Since rate transmission is now smooth, any rate increase by RBI will be immediately reflected in their home loan rate. Any increase in home loan rates will increase the EMI (or loan term) and could mess up your financial planning.
For example, the EMI for a 20-year home loan of Rs 1 crore will be Rs 75,739 @ 6.7%. The same will go up to Rs 81,787 @ 7.7% and drop to Rs 88,052 @ 8.7%. The best thing to do in situations like this is to opt for fixed rate loans. However, the options are very limited and only a few options offer fixed rates for a limited period. More importantly, these partially fixed rate home loans also charge higher interest rates.
Partially fixed loans will cost you more
Consider the additional costs before opting for partial fixed loans.
While these rate increases are out of your hands, you can prepare for them by assuming a higher interest rate. “Instead of today’s very low rates, assume a reasonable mortgage rate of around 8.5% and systematically invest the remaining EMI elsewhere,” says Aparna Ramachandra, founder and director of Rectifycredit.com. For example, the EMI for a 20-year home loan of Rs 1 crore is Rs 86,782 at 8.5% and will be Rs 75,739 at 6.7%. You should invest the difference of Rs 11,043 in a short-term debt fund every month. This corpus will serve as a backup if prices increase. You will be in a better position even if the rate does not increase, because this money will be invested in savings instead of being spent.
Take a home loan? Make sure your financial plan isn’t impacted, ask yourself these 5 questions…
Can you afford to take out a home loan?
Like many others, you might also be tempted to accept those home loan interest rates that have been the lowest in a decade and make the most of falling house prices before the things do start to straighten out and get back to normal. While these external factors seem attractive, the decision to take on more debt to buy a home also depends on certain factors about you and your finances.
For many, buying a home means stretching finances to an uncomfortable limit and stretching themselves too thin in the process. Before you apply for a big home loan, make sure you’re on solid ground when it comes to your personal finances and goals. Ask yourself these five questions about your emergency fund, down payments, EMIs, and the status of other financial goals, to make sure your home loan doesn’t end like a noose around your neck.
Is your emergency fund in place?
Before you even start crunching the numbers, you need to make sure your foundations are in good shape. The emergency corpus must be large enough to cover all your expenses for the next 12 months. This should also take into account the new EMI commitments on the home loan. This is to provide an immediate financial cushion in the event of loss of income due to job loss, accident or prolonged illness. Having that buffer when paying off a large home loan has proven invaluable over the past 18 months.
Is the down payment too large?
Banks ask borrowers to disburse 20% of the value of the property up front before agreeing to sanction a loan for the remaining amount. However, you can put a higher amount if you wish. For a property priced at Rs 90 lakh, the maximum sanctioned loan will be Rs 72 lakh, which means you pay Rs 18 lakh as down payment. Moreover, you also have to pay a few lakhs for stamp duty and GST, the latter only if you opt for a property under construction. Together, these expenses represent a handsome sum for the majority. Even so, financial advisors generally suggest opting for the maximum possible down payment.
A smaller loan component not only invites lower interest rates and reduces the burden of EMIs, but it also reduces total interest expense and allows for faster repayment, Joshi insists. However, borrowers should not empty all of their accumulated savings into the down payment. When considering the amount of savings you have available for a down payment, don’t forget your retirement and other essential life goals. Do not withdraw money set aside for these purposes. Also consider expenses for renovations or furnishing your new home. Then, after providing for the emergency corpus cushion, what remains can be invested in the down payment. Also, a large down payment will become a strain on your cash flow.
How much will NDEs weigh on you?
Budgeting for IMEs is another tricky aspect. Typically, a bank assumes that around 50% of your monthly disposable income is available for repayment. No bank will grant a loan beyond this threshold. This includes your current EMI commitments, if any. “Some banks have become aggressive and are willing to go beyond 40% EMI if the borrower meets certain criteria,” points out Rohit Shah, CEO of Getting You Rich. But the lender’s internal EMI cap may not be realistic for everyone. For example, if you earn Rs 1 lakh every month and incur expenses of Rs 60,000, then an EMI of Rs 40,000 is simply unaffordable. You would live day to day in such a scenario. If you buy a property under construction, you will probably pay rent with your EMI. Make sure you can afford it even if the bank is willing to give you a large loan. Stretching your budget is okay up to a point, as your income will increase, but the IMEs will not. But don’t overdo it.
Do you know the tax calculation?
Some borrowers are simply sold on the tax benefits that a home loan allows under income tax rules. These deductions, which effectively reduce the cost of the loan over its lifetime, often encourage borrowers to take on heavy EMI commitments. But remember that these benefits only accumulate up to a certain threshold. An individual is allowed to deduct up to Rs 2 lakh per annum for interest payments on home loans. If you repay a 20-year home loan of Rs 75 lakh at 7% interest, the interest expense will be well over Rs 2 lakh for several years. Even if you opt for a joint home loan with your spouse, where both husband and wife can claim a deduction of Rs 2 lakh each per year, the deductions are well below the actual interest spent for the first few years. So don’t extend the EMI home loan for tax benefits alone.