Millions of home loan borrowers, who are servicing their loans, continue to receive letters informing them of a rise in interest rate from their lenders every now and then in the past three years. Interest rates, which were in the range of 6.5% to 7% two to three years back, gradually started scaling up and reached 9 to 9.5% by March 2023.
The lenders started extending the repayment term allowing the borrowers to continue to pay the existing EMIs, till they are 65 to 70 years of age. It is virtually a lifetime debt trap; without understanding the repercussions, lakhs of home loan borrowers have already fallen into the debt trap.
Until interest rates were increased by 1.5%, the lenders went on to increase the repayment term, but when the interest rates increased beyond 1.5%, lenders had to increase the EMIs also, as the existing EMIs were not even sufficient to cover the applicable interest payable thereon in the existing EMIs.
Hardship of borrowers
The following illustration will make us understand the hardship being faced by home loan borrowers.
Mr. Anand Rao, 40 years old, a soft engineer working in an MNC, availed of a home loan of ₹60 lakhs in Jan 2021 to buy an apartment, when the interest rate charged was 6.5% pa., and for a repayment term of 20 years (240 months), the EMI was ₹44,735.
Mr. Rao received a letter in June 2021 informing him that the interest rate charged on his home loan has been increased to 7%, as per the increase in Repo Rate by the RBI (Reserve Bank of India).
The increase in interest rates puts many borrowers under financial stress and hardships. They are worried if interest rates go on increasing in the future whether they will be able to repay the loan in their lifetime. | Photo Credit: istock.com/tameek
Keeping existing EMI
Although the bank offered both options of either increasing the EMI accordingly or extending the repayment period (number of EMIs), he was lured to select the option of keeping the existing EMIs. Thus, the balance term got extended to 247 months from 234 months. Mr. Rao was not made aware that in the revised repayment schedule, he will end up paying additional interest of ₹8,85,000!
In Jan 2022, a similar letter was issued by the lending bank to Mr. Rao, informing him of the increased rate of interest to 8% and luring him to continue to pay existing EMIs. The extended repayment term went up to 309 months, and interest went up by ₹33 lakhs compared to the original repayment term! By opting to keep the existing EMIs, the repayment term was extended by 309 months (25 years and 9 months), the time when Mr. Rao will be 65 years of age!
In June 2022 and in Jan 2023, when again interest rates were increased to 8.5% and 9%, respectively, the bank was forced to increase the EMI amount, as the existing EMI was not sufficient to even service the interest portion in the EMIs. Thus, EMIs were increased to ₹47,873 and ₹49,859, respectively, restricting the repayment tenure up to the age of 65 years of Mr. Rao.
If further interest rates are not changed, the total interest payable would be ₹85.5 lakhs as against the principal amount of ₹60 lakhs!
The increase in interest rates has thus forced Mr. Rao to face financial stress and hardships beyond one’s imagination, and the trauma continues to haunt him, if interest rates go on increasing in the future, whether he will be able to repay the loan in his lifetime?
Many home loan borrowers look for better alternatives like switching to fixed-interest loans or transferring their home loan account to another bank, which offers less rate of interest. | Photo Credit: istock.com/zenstock
Better alternatives
Millions of home loan borrowers like Mr. Rao, who are sailing in the same boat, are looking for better alternatives like switching to fixed-interest loans or transferring their home loan account to another bank, which offers less rate of interest. For long-term (beyond 5 years) loans, seldom any bank offers fixed-rate home loans, and even 5 years fixed-rate home loan attracts a prohibitive interest rate of 2.5 to 3% more than floating-rate home loans.
The option of shifting the home loan account to another Bank or HFC (Home Finance Company) could be a possible option, but one needs to weigh the pros and cons before jumping to another bank, as home loan terms are complex and need a proper study of financial calculations and implications thereon.
Let us see if Mr. Rao opts for a balance transfer of his home loan account to a leading bank with a proven track record of transparency and offering good service, which charges him a rate of 8.35% as against the existing 9% interest rate per annum, what could be the advantages.
The new repayment terms include an interest rate of 8.35 % per annum, the same tenure of 23 years (276 months), and an EMI of ₹47,362. In this option, Mr. Rao saves ₹2,500 every month, which makes a total savings of a whopping ₹6.9 lakhs!
To opt for this, there may not be any pre-closure charges levied by the existing lender, but there shall be expenses such as mortgage release expenses. Further, the new bank will charge him a processing fee, legal fees, and also mortgage stamp duty, etc, which may work out to ₹25 to 30,000 approximately.
Rising home loan interest rates is a constant worry for borrowers. | Photo Credit: Getty Images/iStockphoto
Proper guidance
Proper planning under the guidance of a seasoned professional can further make the balance transfer offer more beneficial and also help the borrower to even get rid of the loan, much earlier, and without further expenses.
In Mr. Rao’s case above, it is suggested as follows.
Let Mr. Rao, open a SIP (Systematic Investment Plan) for a monthly contribution of ₹2,500 (saving made in the EMI outgo) account with an established Mutual Fund AMC (Asset Management Company). By considering the 10% interest earned on the SIP scheme, the accumulation of the interest saved in the balance transfer option, could become as high as 27 lakhs in 23 years! By considering the initial expenses of ₹30,000 on the balance transfer option and 10% national interest calculated thereon for 23 years, the total expenses would be ₹290,000.
After deducting this outgo of ₹2,90,000, still, the total savings on account of the balance transfer option will be ₹24,10,000! As and when the corpus in the SIP Scheme equals the outstanding loan amount, which may happen between 15 to 20 years, Mr. Rao can pre-close the home loan and be free from the shackles of lifetime debt!
Thus, it is advisable to opt for the balance transfer option if the interest rate difference is even half a percent (0.5%), but it needs to be exercised under the guidance of a seasoned financial planner.
(The author is the Managing Director of PropSeva)
