What is the Repo Rate?
Think of the repo rate as the interest rate at which the RBI lends money to commercial banks. It's a powerful tool used to manage money supply and control inflation in the economy. When the RBI increases the repo rate, it becomes more expensive for banks like
HDFC, ICICI, or SBI to borrow money. And just like any business passing on higher costs, banks pass this on to their customers by increasing interest rates on loans, including home, auto, and personal loans.
Why Is the Rate Going Up?
The primary reason for a repo rate hike is to tackle rising inflation. Recent trends show increasing pressure on prices due to factors like higher global oil prices and other geopolitical tensions. By making borrowing more expensive, the RBI aims to reduce the amount of money circulating, which in turn cools down demand and helps bring prices under control. Economists and major banks widely anticipate a rate hike of around 0.25% in the RBI's October policy meeting, which would be the first such increase in a long time.
How Your Loans Will Be Affected
If you have a loan with a 'floating' interest rate, you will feel the impact directly. Most home loans and many personal loans in India are linked to an external benchmark, which is often the repo rate. When the repo rate increases, your bank will revise its lending rate, and your Equated Monthly Instalment (EMI) will increase. For those on a fixed-rate loan, your EMI remains unchanged for the duration of the lock-in period. However, any new fixed-rate loans taken out after the hike will be offered at a higher interest rate.
Strategic Moves for Young Borrowers
Instead of panicking, you can take several smart steps to manage the higher EMI burden. First, review your monthly budget to accommodate the increased payment. If you have surplus funds, consider making partial prepayments on your loan. This reduces the principal amount, which can lower your future EMIs or shorten the loan tenure. Another option is to increase your EMI amount voluntarily if your finances permit. While it feels like a bigger hit now, it helps you pay off the loan faster and save on total interest. Lastly, some borrowers might consider extending their loan tenure to lower the monthly EMI, but be aware this means paying more interest over the long run.
Should You Switch to a Fixed Rate?
In a rising interest rate environment, switching from a floating to a fixed-rate loan can seem appealing for the stability it offers. However, fixed rates are typically higher than current floating rates, and you might lose out if the RBI decides to cut rates in the future. Experts suggest that the current hiking cycle might be a shallow one. Before making a switch, calculate the break-even point and consider the prepayment penalties and processing fees involved in refinancing. For many, sticking with a floating rate and managing payments smartly might be more beneficial.
