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Managing rising interest rates
Source: content.magicbricks.com Sep 16, 2011
Rising interest rates are giving sleepless nights to Shankar. He had taken a home loan of Rs 15 lakhs in 2006. The interest rate was seven percent then. His EMI was Rs 12,000, which was quite comfortable to manage with his income. Just like many of his friends, he had also opted for the floating interest rate, although the fixed rate loan was available at 8.5 percent. His age was 35 years. The loan tenure was 15 years.

However, things have become difficult since then.The interest rates have been increasing gradually. The key rates have been increased by the Reserve Bank of India (RBI) about 14 times in the recent past. He is in a dilemma. What should he do now? Every couple of months the bank sends him an interest revision letter. The latest intimation letter informed that the interest rate had been revised to 13 percent. His EMI has been revised to Rs 16,000.

This is hitting his budget hard. So, what are the options before him to meet this crisis? Analysts say more increases in the coming months are possible. Let us look at a few options available to him. First, he can extend the tenure of the loan. This way, he can increase only the tenure of the loan and keep paying the same EMI. As he is 40 years old now, he can have the loan extended to 20 years - till his retirement age of 60 years. Most banks restrict the loan tenure to the retirement age of the borrower.

Extending the loan tenure is like buying time. Extending the tenure increases the interest burden on the borrower. This option suits a borrower whose loan is set to finish in the near future - about five years.

The other option is to prepay a part of the loan. So, if he has some excess cash of say Rs 5 lakhs, he can prepay a part of the loan. He can again keep paying the same EMIs despite the increase in the interest rate. Prepaying a part of the loan is one of the better ways to bring down the loan burden. He may encash his savings or investments to prepay the loan. A dilemma here is that equity investments are already adversely affected because of the volatile stock markets. Further, fixed deposits are earning a good rate of about nine percent.

There is yet another option - that of increasing the EMI amount. In case he is expecting a rise in his income in the near future, he can opt for a higher EMI amount. This way, he can repay the loan over a shorter period of time. A higher EMI absorbs the impact of a rise in the rate without increasing the tenure. This option assumes that he can easily manage the higher EMIs without upsetting his monthly budgets.

This in fact may reduce the loan tenure. In case the interest rate comes down, it will further reduce the loan tenure. So, if after one year the interest rate is rolled down to nine percent, he may end up repaying the loan much faster than the original loan tenure. The suitability of each alternative depends on the type of home loan,its balance term and the loan amount.
Tag: Real Esate, Interest Rates, Home Loans, Budget
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