Is your home loan crushing you?

How badly is the EMI (equated monthly instalment) of your home loan messing up your budget? Over the last four years, the interest rate on home loans has risen from the bottom of about 7.75 per cent in 2004 to about 12.75 per cent now for existing customers. During the initial period of the rise, your lender bank or housing finance company (HFC) increased the loan tenure, till it went up to the end of your expected working life. Then it started bumping up the EMIs. Your total interest burden would have more than doubled from what it was in 2004 unless you have already prepaid substantial chunks of your principal.

This larger loan burden comes at a time when rising prices are putting pressure on your budget anyway. To cap inflation, the government and the Reserve Bank of India (RBI) have been tightening the screws on liquidity. The RBI has increased the cash reserve ratio (the amount banks set aside with the RBI) and the repo rate (the rate at which banks borrow from the RBI), sucking out cash. So, banks are having to pay higher interest on deposits to bring in cash. To make money on these higher-cost funds, they have had to hike lending rates. This has pushed up the overall interest rates.

The biggest impact of this increase is on home loans. Those who took fixed rate loans have been guarded against this since the rate is likely to be reviewed after five years or so. However, those who took floating rate loans have borne the brunt of the rate hike, seeing their repayment tenures and EMIs shooting up.

While there have been reports of suicides over inability to repay home loans in the US after the sub-prime crisis, we haven’t heard anything such in India yet. But the task of making ends meet without losing the roof over one’s head is stressing people out. So, how do you ease the pressure, even partially?

THE SHOCKS
To find a way out, you have to understand how interest rates are set. Banks calculate their own cost of funds from various sources. Above that, they fix the prime lending rate (PLR), a rate at which they lend money to their best or least risky customers. Normally, all banks also fix a benchmark PLR (BPLR). All loans are linked to the BPLR. When interest rises, the PLR and the BPLR increase. This, in turn, pushes up the rates for the floating home loan buyers, since the rate of interest they pay is linked to the BPLR. Then comes the increase in loan tenure and, subsequently, EMIs.

Longer tenure, higher EMIs. Take the case of a 30-year-old who had taken a Rs 30-lakh home loan in 2004. At an interest rate of 7.75 per cent per annum then, he was supposed to pay an EMI of Rs 24,628 for 240 months to repay his loan. Typically, most banks provide a loan tenure of up to 240 months. The total interest outgo over this period would have been Rs 29 lakh. So, the total cost of his home would have been Rs 59 lakh. By 2006, when interest moved to 9.5 per cent on the same loan, on the same EMI, the tenure was pushed to 26.61 years. A 1.75 per cent increase in the interest rate pushing up the tenure by 8.61 years!

Higher interest outgo. Today the same loan runs on an interest rate of 12.75 per cent. Over the last four years, the bulk of what he has been repaying as EMI is interest. So, he still has an outstanding principal of Rs 27 lakh to repay and his EMI is up to Rs 29,774. This is what the situation is: a loan, originally for 240 months with an EMI of Rs 24,628, gets rolled into one for 319 months with an EMI of Rs 29,774. The horror story does not end there. On the outstanding principal of Rs 27 lakh now, the total interest burden for 26.61 years is a whopping Rs 68 lakh, and the total cost of the Rs 30-lakh home has become Rs 98 lakh, including Rs 3 lakh that has already been paid.

Higher total cost. Every time the interest rate goes up by 0.25 percentage points, the repayment period gets longer. For instance, on a loan at 9 per cent, if the original repayment tenure was 240 months, a 0.25 percentage point increase after, say, a year lengthens the remaining payback period by 11 months to 239 months. A 1 percentage point increase prolongs the tenure by 60 months, taking the total tenure to about 288 months (see With Every Hike). With the loan amount constant, more the number of EMIs you pay, the higher the interest cost, and, therefore, the total cost of your home.

Typically, for a buyer, it is difficult to look at his home in a clinical sort of way. The emotions and other intangibles play a strong role. He’ll usually try to cut back on everything else to retain the house, even if its cost has gone way above what he was looking at when he bought it. Even though he doesn’t, strictly speaking, own the home yet, in his mind he does. Thus, selling is not really an option. So, what can he do to reduce the financial pressure?

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