On 8 June 2023, the Reserve Bank of India increased the Repo Rate by 25 basis points, making the current Repo Rate 6.50% per annum. The central bank of the country had slashed the Repo Rate in the aftermath of the Covid-19 pandemic. The Reserve Bank of India started rate cuts in June 2019 and by October 2020, it had brought the Repo Rate down to 4%, which is the lowest the Repo Rate had been in a long time. However, primarily to bring inflation under control, the apex bank of the country has been slowly increasing the Repo Rate again.
What is the Repo Rate? How does it affect a common man’s loan? What is the Repo Rate effect on home loans? These are common questions that people have and, in this article, we try and answer these questions.
The economy of a country is governed largely by policy rates, which are an important monetary policy tool that the central bank of a country uses to ensure a stable and liquid banking system, control the flow of funds within an economy, and keep inflation under check. The Reserve Bank of India has two key policy rates that it effectively uses for these purposes from time to time: Repo Rate and Reverse Repo Rate.
The Repo Rate is the interest rate at which the apex bank of this country, i.e., the Reserve Bank of India, lends money to banks and commercial lenders operating within the country. The apex or the central bank of the country increases the Repo Rate when it wants to make credit expensive.
When the RBI increases the Repo Rate, borrowing money becomes expensive. Lenders must pay a higher rate of interest to the RBI and lenders pass on these rate hikes to the borrowers. Repo Rate increase effects reach borrowers in the form of expensive credit, which in turn, acts as a dampener. Thus, when the Repo Rate goes up, the demand for credit goes down. This also helps bring the demand for goods and services under control. In other words, Repo Rate hikes help the Reserve Bank of India curb inflation by restricting the flow of money within the economy and therefore, the demand for goods and services.
On the other hand, Repo Rate cuts help boost the flow of funds within the economy by making credit cheap. When the Repo Rate goes down, the cost of credit goes down too, which helps boost consumer demand. In conclusion, the impact of Repo Rate changes is significant and it is thus that citizens of a country must keep themselves apprised about policy rate changes.
Until 2019, banks and commercial lenders were not obligated to link their loans to an external benchmark. This led to the absence of transparency within the loan processes. Thus, every time the RBI increased the Repo Rate, lenders increased the interest rate they charged on loans. However, every time the RBI cut the Repo Rate, lenders would not pass on the benefits to the borrowers, at least not immediately.
Thus, in October 2019, the Reserve Bank of India made it mandatory for all lenders to link all home loans, including home loans, personal loans, car loans, etc., to an external benchmark. Most lenders chose to link their loans to the Repo Rate. Now every time the RBI increases or decreases the Repo Rate, there is a direct impact on an individual’s EMIs.
After the Covid-19 pandemic, when the country’s economy was reeling, the Reserve Bank of India slashed the Repo Rate to 4% in May 2020. This helped reduce the cost of borrowing credit and stimulate demand. Lenders could borrow credit from the Reserve Bank of India at a much lower rate of interest and therefore, could lend also at a much lower interest rate. Thus, after the Covid-19 pandemic, all loans, including home loans, became cheap. This helped boost liquidity and demand within the system, especially within the real estate sector. People who had been planning to buy a home for a long time finally took the plunge and became homeowners. It was a smart decision too. After all, with the Repo Rate at 4%, most lenders were offering home loans starting as low as 6.50% per annum. Thus, homebuyers could make their dream home their own by paying as low as only Rs.632 per lakh as EMI.
However, over the last two years, while the economy has been showing strong signs of recovery, inflation has been growing unabated. Thus, the RBI has been slowly increasing the Repo Rate, primarily to curb inflation and help bring prices of goods and services under control. The last Repo Rate hike happened in February 2023. Since then, the Reserve Bank of India has kept the Repo Rate unchanged.
How does a Repo Rate hike affect a person’s home loan EMIs? Let us understand this with an example.
Let’s assume Mr. A decided to become a homebuyer in 2019 when the Repo Rate and therefore, the home loan interest rates were quite low. He availed himself of a home loan worth Rs.75 Lakh on floating interest rates. Back in 2019, when the Repo Rate was 4%, Mr A could avail himself of a home loan at an interest rate of 6.50% per annum. Thus, his home loan EMI was Rs.47,405 in 2019. However, by August 2022, the RBI had increased the Repo Rate to 5.40%. Mr. A’s lender immediately passed on these Repo Rate hikes to him and therefore, by August 2022, Mr. A’s home loan EMIs had increased to Rs.54,510 because by 2022, his lender had increased his home loan interest rates to 7.90% from 6.50%. The current Repo Rate is 6.50% per annum, which is 2.50% higher than the Repo Rate in 2019. At present, most lenders are charging close to 9% on home loans. Thus, in 2023, Mr A must be paying Rs.60,347 as a home loan EMI. Thus, between 2019 and 2023, facilitated by a total of 2.50% hike in the Repo Rate and an equivalent home loan interest rate increase, Mr A’s home loan EMIs increased by almost Rs.13,000.
So, how do Repo Rate hikes affect a person’s home loan EMIs? When the Repo Rate goes up, not only does credit become expensive and borrowers must pay higher interest on fresh loans, but borrowers repaying a loan on floating interest rates find their EMIs going up and some borrowers may even find loan repayment becoming a hassle. If you are finding it difficult to repay your current home loan EMIs due to increased home loan interest rates, here are a few tips that might help make repayment simple for you.
Simple Tips on What Borrowers Can Do to Reduce Their Home Loan EMIs
Part Prepay Your Home Loan: If the recent Repo Rate hikes have made your home loan EMIs unaffordable to you, you can benefit from a part prepayment. Part prepayment refers to the process of making a lump sum payment towards your home loan. This helps reduce the principal, which in turn, helps reduce one’s home loan EMIs. Use funds from your yearly bonus or an FD maturity or share sale to arrange the funds needed to make a lump sum payment.
Balance Transfer Your Home Loan: Home loan balance transfer refers to the process of transferring your outstanding home loan amount to another lender offering better terms and conditions. If you think your current lender is charging you a very high rate of interest on your home loan and another lender is willing to offer you a lower interest rate, you can transfer your remaining home loan amount to this new lender. However, if you go for a home loan balance transfer, keep two things in mind. First, a home loan balance transfer makes sense during the early years of one’s loan tenor, i.e., when a considerable portion of one’s interest is yet to be paid. Second, if you opt for this facility, you will be charged a home loan balance transfer fee. One must therefore opt for this facility only when the savings facilitated by the home loan balance transfer facility are high enough to cover the cost of the transfer, over and above helping the borrower save money by way of a reduced home loan interest rate.
The Repo Rate is an important monetary policy tool that the Reserve Bank of India uses very effectively to regulate liquidity as well as the flow of funds within the economy. The Reserve Bank of India can change the Repo Rate every three months and every time the RBI changes the Repo Rate, home loan interest rates and therefore, home loan EMIs change too. Therefore, all borrowers, especially home loan borrowers, must keep track of Repo Rate changes and Repo Rate effect on home loans.
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