Vivek Sharma is the only bread earner for a family of four and their dreams of owning an apartment have remained a distant, beautiful dream thanks to the high interest rates on home loans. And then the change happened; the change of ‘Demonetization’. Vivek is an extended metaphor for all the individuals who have saved up their dreams of owning an apartment or house due to high home loans. But that is not the case today and this article evaluates how demonetization will affect the graph of home loan interest rates and by how much.
As the chart depicts, one of the direct side effects of demonetization is the pressure on withdrawal limit. With the ban on 500 and 1000 notes, people started to deposit their surplus cash, both the old income and new income cash, into the banks. But with a limit on withdrawal, and 80% of the cash in hand deposited in banks, the latter will soon reach its limit of having cash within itself. Therefore, more deposits in banks would automatically result in more money circulation among bank.
As well known, before the entire demonetization occurred, 60% of the unaccounted money ran in circulation among the people itself but following it, this money reached banks, which lead to a surplus of cash in the banks. As a side effect of this, the RBI soon cut the repo rate (or the rate at which the RBI lends money to the commercial banks). Now this is where we come to reduced rates on home loan interests. Since the repo rate and home loan rates are directly related, the reduction in repo rate automatically reduces the fixed deposit rates and also the loan interest rates as well and thereby, produce a drop in lending rates too. The increase in low-cost deposits provides a good probability to bring down the bank deposit rates. The State Bank of India, which is India’s leading state run lender, has already cut its base rate and is now lending at a rate of 9.35% for loans more than Rs.20 lac and at a rate of 9.25% for those loans less than 20 lac. If these benefits are not passed onto the existing customers, there are two other ways in which the loan borrower can avail it:
- By converting their existing loan rates to the current rates after paying a heavy penalty of a minimum scale of 0.56% on the leftover principle, either to the banks or to the respective lending institution.
- By making the choice to switch to a new bank or a lending institution.
The State Bank of India offers the lowest interest rates, especially under its festive discount for loans with a loan interest of 9.15% for loans up to Rs. 75 lacs, which has been sanctioned in November and December. Private lenders such as HDFC and ICICI rates circle at rates of 9.2% for home loans for an amount of up to Rs. 75 lac as a down from 9.35% for the same. There are also predictions of a reduction rate by 10-25 bps in the interest rates.
The following table covers the range by which the fixed deposit rates have decreased across banks:
Thus for a loan amount of Rs. 50 lacs at 9.5% interest for 20 years, a 25 basis point cut would then reduce the EMI payable each month by RS.812. Instead of affecting this reduction on the EMI, lenders usually leave the EMI amount unchanged and reduce the loan term when rates are cut. Therefore, longer the remaining tenure, greater will the impact be, since the extend of the reduction will depend on the balance tenure of the loan.
For those who are already under a home loan scheme and for those who are planning to commit to one, it has to be considered that the Reserve Bank of India’s hike in the repo rate is reflected instantly in the banks changing theirs as well, and when the RBI cuts down on its repo rate, the banks did accordingly too, but only at a painstakingly long time. Thus, the RBI introduced the feature of the MCLR, ie. Marginal Cost of Lending Rate. Under the MCLR, the banks are required to change their interest rates periodically. Hence, the interest rates of the banks can now be expected to change quicker. If you have applied for a loan under the MCLR scheme, you stand at the receiving end of benefits from demonetization where your bank will slash down on its interest rates. The MCLR rates are set for a period of one year with subsequent dates for resetting the dates through the loan tenure. Therefore, once the loan scheme reaches its period of reset, the loan applicant can benefit from the lower interest rates occurred as a side effect of demonetization, in effect bringing down the monthly installment while upping the cash in hand.
On the other hand, if the applied home loan is under a fixed rate of interest, it is highly unlikely to be affected by demonetization. In other words, under a fixed rate of interest scheme for home loan, the rates will remain unchanged for the entire tenure, irrespective of the rising or falling market trends.
Until recent developments, the focus was on offering solutions for the premium and upper-mid range segments as the developers expected to experience a high demand on this space; under the current scenario, there has been a surge in purchases by end-use customers who now constitute as much as 90% of the aspiring home buyers, thus shifting the attention of the developers to the affordable housing segment.
In addition to the wave of demonetization hitting hard on the real estate sector, there have also been other buyer friendly provisions such as the Real Estate Regulatory Act, which spikes up the transparency level in the real estate sector by protecting from delays in construction and handover as well as other unscrupulous practices exercised by developers. All such measures, when put together, make this the perfect time to chase your dream home into a reality.
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