In a surprise move, last week, the Reserve Bank of India announced a 25 basis point cut in the Repo rate (rate at which RBI lends to commercial banks) and if the Minister of State for Finance, Jayant Sinha, is to be believed, the banks are expected to announce a cut in their base rates in the near future. A cut in rates by banks would mean a lot for both borrowers and investors. While the equity investors saw an immediate benefit in terms of a jump in the equity markets on the day the rate cut was announced and the 30-stock benchmark Sensex hit the 30,000 mark, the debt investors and loan seekers would benefit once the banks announce a cut in base rates.
Over the last seven weeks, the RBI has cut the repo rate twice by a cumulative of 50 basis points but of the 45 scheduled commercial banks only three banks announced a cut in base rates after RBI’s rate cut announcement in January. However, that is likely to change.
“We have a very competitive financial services industry. Now that the Reserve Bank of India has cut rates by 50 basis points in total (in calendar 2015), I am sure that one or two or three of the major banks will go ahead and cut rates. Once they do that, then all others will have to cut rates,” said Sinha.
What should bank depositors do?
A cut in rates by banks is likely to impact the deposit rates first and a cut in deposit rates would bring down the annual interest income on term deposit with banks for the investors. Therefore conservative individuals, who invest in term deposits would benefit if they lock themselves in long tenure term deposits that will earn them a high interest rate.
If the deposit rate in a five-year term deposit goes down by 50-basis point from 8.5 per cent to 8 per cent then over five years, the value of a Rs 10 lakh fixed deposit will go down from Rs 15.03 lakh to Rs 14.69 lakh, a decline in return of Rs 34,300.
While the interest rate is expected to go down by around 100 basis point over the course of the year, if banks cut deposit rate by 100 basis points then over five years, the return on RS 10 lakh fixed deposit would go down from Rs 15.03 lakh to Rs 14.35 lakh, a decline of Rs 68,000 in return.
So it would be beneficial for FD investors to invest now before the rates see a cut. On the other hand debt investors of mutual funds would benefit with more cut in rates as that will result into capital gains on their investments.
What should borrowers do?
Home loan borrowers would however do well by not going for fixed rate loans even though banks or housing finance companies may be offering lucrative interest rates.
If the RBI goes for a rate cut of 100 basis points over the next one year then home buyers who go for fixed rate schemes will miss out on the advantage of a rate cut in the economy.
In case of a floating rate loan, if banks cut their base rate by 100 basis point from 10.5 per cent to 9.5 per cent over the next one year, then the EMI for Rs 20 lakh loan would go down by Rs 1,325 from Rs 19,967 to Rs 18,642 resulting in an annual savings in EMI of Rs 15,900 for a new customer.
For an existing customer, either the EMI can come down by up to Rs 1,325 per month or the tenure on the outstanding loan can go down by up to 40 months for a 20 year loan. If the remaining tenure of the loan is 180 months, then it would go down to 160 months.
Financial planners also suggest existing customers to evaluate their fixed income investments going forward and see if it is better to prepay the loan as the return on fixed deposits will fall going forward.
“If your fixed deposit is maturing in three to six months then you must evaluate whether to roll it over or to use it for prepayment of your loan as your FD will earn you lower interest rate,” said Vishal Dhawan, founder Plan Ahead Financial Advisors.