RBI Repo Rate Hike: Economists have given indications of increase in repo rate, know how much will be the impact on EMI of home, auto and personal loans and the mathematics of the loan.

For crores of middle-class families and salaried citizens of the country, bank loans taken for their house, car or children's higher education form the largest part of the monthly household budget. In such a situation, the signals coming from the financial corridors regarding the upcoming review meetings of the Monetary Policy Committee (MPC) of the central bank i.e. Reserve Bank of India (RBI) are going to draw lines of worry on the foreheads of common borrowers. Leading financial rating agencies, investment banks and leading economists in the country and abroad believe that the Reserve Bank may tighten its liberal or neutral policy amid the continuing heat of inflation, unexpected fluctuations in food prices and international geopolitical tensions. If the central bank decides to increase its key policy rate 'Repo Rate', then commercial banks will immediately increase their floating loan interest rates, which will have a direct and immediate impact on the loan EMIs deducted from your pocket every month.

Top economists who closely analyze the global and domestic financial markets believe that the stability in interest rates that has been maintained for the last few quarters is now at an increasing risk of a break.

Main economic pressures being created on RBI to increase interest rates:

• Food and core inflation pressures: There is continuous volatility in the prices of fruits, vegetables, pulses and edible oils due to unexpected changes in weather during the last phase of monsoon and disruption in the supply chain. When food inflation remains high for a long time, it also provokes 'core inflation', which central banks have no direct weapon to control except by raising interest rates.

• Crude Oil Prices and Rupee-Dollar Equation: The rise in prices of Brent Crude oil in the international market increases the pressure on India's import bill. It becomes necessary to maintain a competitive balance in interest rates to avoid unnecessary depreciation of the Indian Rupee (INR) against the US Dollar and to prevent the exodus of Foreign Institutional Investors (FIIs).

• Policies of Global Central Banks: Global liquidity remains tight due to the aggressive interest rate strategy of the US Federal Reserve (US Fed) and the European Central Bank (ECB). For emerging economies like India, there is a risk of capital outflow due to low interest rate differential.

• Credit Growth Vs Deposit Growth in Banking System: At present, the pace of loan giving by Indian banks (Credit Growth) is much faster than the money deposited with them (Deposit Growth). Banks have to increase fixed deposit rates to raise funds, due to which their 'Cost of Funds' is increasing and they are ultimately forced to pass the burden on the borrowers.

Before October 2019, whenever RBI increased the repo rate, banks used to take several months to increase their interest rates. But in October 2019, the Reserve Bank made the provision of 'External Benchmark Lending Rate' (EBLR) mandatory for all commercial banks (like SBI, HDFC, ICICI, PNB, BoB). Most banks link their floating rate loans (especially home loans, car loans and MSME loans) directly to the RBI's repo rate, called the 'Repo Linked Lending Rate' (RLLR).

The rules of this system are very clear and cruel:

• As soon as the Monetary Policy Committee of RBI announces an increase in the repo rate by 25 basis points (0.25%) or 50 basis points (0.50%), the banks' computer system automatically increases your loan interest rate by the same amount.

• In most of the banks, this amendment becomes effective from the first day of the month following the announcement. This means that as soon as the policy rate increases, the borrower has to pay the increased rate without any delay.

If, as per the estimates of economists, the RBI increases its interest rates by 25 to 50 basis points, then how much impact it will have on your monthly EMI and total interest on different loan slabs for a tenure of 20 years (240 months) can be understood from the table given below:

Note: This calculation is based on the standard amortization formula of 240 months. Actual rates may vary slightly depending on spreads and credit scores of different banks.

Whenever interest rates rise, most banks do not increase the EMI amount of customers immediately, rather they postpone the loan tenure by 1 to 3 years either with the customer's consent or under an automatic clause. At first glance, the customer thinks that his EMI is being deducted only at ₹ 43,391 and it does not make any difference to him, but this is a big financial illusion (Tenure Trap).

The scary aspect of increasing the loan tenure:

• If the 20 year loan tenure increases to 23 or 24 years, you are paying more in 'interest' to the bank than just your principal.

• Many times the interest rates increase so much that the monthly EMI does not even cover the interest of that month, which is called 'Negative Amortization' in banking language. In this, despite paying the installment every month, your loan starts increasing instead of decreasing. Therefore, read every reset letter coming from the bank carefully and check by how much your period has been extended.

Apart from home loans, this increase has a multi-dimensional impact on other retail loans as well:

• Car and Auto Loans: Most auto loans are 'fixed rate', so for people who already have a car loan, there will be no impact on their old EMIs. However, those who are planning to buy a new car or bike in the upcoming festive season (Navratri and Diwali) will now get new loans at costlier interest rates up to 0.50%.

• Personal Loan and Consumer Durable Loan: Since personal loans are unsecured, banks immediately increase their interest rates from 11-12% to 12.5-13.5% by adding risk premium, which will make loans taken for marriage, treatment or travel expensive.

• Credit Cards and Revolving Credit: Credit card rollover interest rates are already as high as 36% to 42% per annum. In an environment of financial tightening, banks may further increase overdue charges and finance charges.

While the increase in repo rate is bad news for borrowers, it brings a silver lining for crores of senior citizens, pensioners and conservative investors of the country. When banks need to raise funds and RBI increases its policy rates, banks immediately increase their fixed deposit (FD) and recurring deposit (RD) interest rates.

Senior citizens are given 0.50% more interest by banks than general customers. In such a situation, interest rates on FD of 1 to 3 years can reach from 7.75% to 8.25% per year. Senior citizens who manage their household expenses only on bank interest will see a visible increase in their monthly interest income.

If you have a home loan or any other floating loan and want to protect your family budget from the spiral of rising interest rates, implement these 5 practical strategies immediately:

• Make Partial Prepayment: Deposit at least 5% of your principal in lump sum every year from any bonus, incentive, tax refund or maturity fund received in the year. If you make a prepayment of even Rs 2 lakh in the beginning for a 20 year loan, your loan tenure gets reduced by 2 to 3 years and interest worth lakhs of rupees is saved.

• Opt for increasing EMI instead of increasing the tenure: When the bank increases your interest rate, give a written application to the bank asking them not to increase the tenure of your loan, but to increase your monthly EMI by ₹ 1,000 or ₹ 1,500. A small additional EMI will save you from the maze of additional interest worth lakhs of rupees.

• Explore the possibility of Home Loan Balance Transfer: Compare your current bank with the current rates of other public and private banks. If another bank is offering you a cheaper interest rate of 0.40% to 0.60%, consider transferring your loan to another bank by paying nominal processing fees.

• Maintain Credit Score (CIBIL Score) 750+: In today's era, banks adopt risk-based pricing. To customers whose CIBIL score is above 800, banks offer loans at interest rates (concession) of 0.25% to 0.35% less than the normal rates. Keep your score strong by paying your credit card bills and other liabilities on time.

• Take Home Loan Overdraft (Maxgain / Advantage) Account: If your bank allows the facility, get your normal home loan converted into an 'Overdraft Linked Home Loan'. In this, you can park the extra cash from your savings account in the home loan account. The bank will not charge interest on the number of days that extra money remains in that account, and you can withdraw that money anytime if needed.

Whatever be the final outcome of the RBI's monetary policy meeting, these clear assessments of economists have made it clear that the era of cheap loans is now on the decline. By being financially cautious, adopting a timely pre-payment strategy and keeping a close eye on your loan reset, you can protect your hard-earned money from the shock of this potential interest hike.