Lending rates to fall further: Should you take a short-term or long-term home loan?

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Updated: December 14, 2016 6:16 PM

As expected, the demonetization of higher denomination Rs. 500 and Rs.1,000 notes has made banks flush with deposits, which have now breached the Rs.11 lakh-crore mark in one month's time since the move came into effect.

The benefit of reduced interest rates will come in the form of lower EMIs, resulting into cheaper home loans till 2018 to a year or two later.The benefit of reduced interest rates will come in the form of lower EMIs, resulting into cheaper home loans till 2018 to a year or two later.

As expected, the demonetization of higher denomination Rs. 500 and Rs.1,000 notes has made banks flush with deposits, which have now breached the Rs.11 lakh-crore mark in one month’s time since the move came into effect. The surge in deposits made lenders like HDFC Bank, Bank of Baroda, Dena Bank and Bank of India cut their benchmark lending rates even without waiting for the RBI monetary policy meet that was held on Dec 7, 2016.

In a move to reduce the cost of funds for banks, the Reserve Bank of India (RBI) has rolled back its earlier decision of mandatory 100% incremental cash reserve ratio (CRR), which the central bank termed ‘as a temporary measure’, to suck out the excess liquidity in the banking system arising out of demonetization.

Now the question everyone’s asking is: whether to opt for a short-term or long-term home loan? Well, “the quantum of home finance is such that it can be a herculean task for a majority of borrowers to pay off the loan in a short period of, say, 1-5 years. That is because when someone decides to pay the loan in a shorter time, either he can do via personal loan alternative with 16-20% rates or can enjoy low rates of home loan of 9-10%, but having the capacity to pay EMI in 5 years,” says Rishi Mehra, co-founder, deal4loans.com.

However, the benefits of the ongoing trend of reducing lending rates are going to be more imminent in 2-3 years from now.

What to expect on the EMI front?

From Jan 2015 to Dec 2016, the RBI has cut the repo rate by 1.75%. Banks, though, slashed the rates by only 0.60-0.70%. However, in the previous monetary policy meet that happened on Oct 5, 2016, wherein the RBI had slashed the repo rate by 25 basis points (100 basis points=1%) to 6.25%, banks responded in equal measure by reducing the lending rates by the same percentage.

Now with bank deposits at an elevated level and expected to touch new levels in times to come, expect your home loan lending rates to go down substantially. Also, the profound change in banks’ approach to adequately transmit the benefits of repo rate cuts to the borrowers, post MCLR mechanism, will also ease the interest rates and the EMIs that follow the same.

“Keeping in view the ongoing scenario, a 1% repo rate cut seems imminent in the next two years. If we assume that banks pass on the benefit to the tune of 70%, the home loan rates could fall by 0.70% by the time we bid goodbye to 2018,” says Mehra.

The benefit of reduced interest rates will come in the form of lower EMIs, resulting into cheaper home loans till 2018 to a year or two later.

For example, “suppose you want to borrow a 20-year home loan of, say, Rs. 20 lakh from HDFC Bank, whose floating interest rates are 9.10%-9.15% p.a. Going by the assumption of 0.70% interest rate cut till 2018, the rates could easily fall to 8.40%-8.45% by the said period,” says Mehra.

Below are the two scenarios depicting the EMI flow on a home loan.

Scenario 1 (Present)
Loan Amount- Rs. 20 lakh
Interest Rate- 9.10%-9.15% p.a.
Tenure-20 Years
EMI- Rs. 18,123-18,188
Interest Outgo- Rs. 23,49,603-23,65,099
Total Outgo- Rs. 43,49,603-43,65,099

Scenario 2 (Applying at 2018-end)
Loan Amount- Rs. 20 lakh
Interest Rate- 8.40%-8.45% p.a.
Tenure-20 Years
EMI- Rs. 17,230-17,293
Interest Outgo- Rs. 21,35,222-21,50,374
Total Outgo- Rs. 41,35,222-41,50,374
(Source: deal4loans.com)

From the chart, you could clearly see the fall in EMIs as we go from scenario 1 to scenario 2. So, you are in for a cost-friendly home loan journey till 2019, the time for which the current dispensation is in place. “Beyond that, there can be positive effects for a year or two. However, it is not sure whether the same government will come to power by 2019. So, a long-term perspective of a home loan would sound immature at this point of time,” informs Mehra.
One advantage of taking a home loan for a shorter period is that short-term loans allow you to reduce the interest burden significantly compared to long-term loans (we will discuss this in a separate story). But this is ideal when you have the financial capacity to pay large EMIs without the certainty of defaulting or having your finances stretched thin. If you can’t do this, then it is better to opt for a longer-term loan. And you should definitely not try to clear your home loan after taking some other loan at high interest rates. This can compromise your financial health.

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