What is the Repo Rate Hike?
The RBI's Monetary Policy Committee (MPC) recently increased the repo rate by 25 basis points (0.25%) to 5.50%. Think of the repo rate as the interest rate at which the RBI lends money to commercial banks. When this rate goes up, it becomes more expensive
for banks to borrow funds. To manage their costs, banks often pass this increase on to their customers. This decision signals a 'calibrated tightening' stance, meaning further rate cuts are unlikely in the near future as the central bank focuses on managing inflation.
Good News for New Savers
For those looking to save, a rate hike is welcome news. Banks are likely to increase the interest rates they offer on new Fixed Deposits (FDs) to attract more funds. This allows new savers, or those whose existing FDs are maturing, to lock in higher returns. However, the change is not automatic. Existing FDs will continue to earn the interest rate at which they were booked until they mature. The benefit applies only when you start a new FD or renew an old one after your bank has revised its rates. Some banks had already started adjusting their rates in anticipation of the policy change.
The Challenge for Floating-Rate Borrowers
The picture is less rosy for individuals with floating-rate loans, such as most modern home loans and some auto loans. Many of these loans are directly linked to an external benchmark like the repo rate. When the repo rate increases, the interest on these loans is adjusted upwards at the next reset cycle, which is typically every few months. This means borrowers will face either higher Equated Monthly Instalments (EMIs) or a longer loan tenure to repay the same amount. A borrower with a fixed-rate loan, however, will see no change in their payments.
How Your Home Loan EMI Could Change
The impact on your monthly budget can be significant over time. While a 0.25% increase might seem small, it adds up. For example, on a ₹50 lakh home loan with a 25-year tenure at an interest rate of 7.5%, a 0.25% hike could increase the monthly EMI by approximately ₹817. Over the full loan period, this could amount to an additional interest payment of around ₹2.45 lakh. Lenders have the option to either increase the EMI amount or extend the loan tenure to accommodate the rate change, keeping the monthly payment the same but increasing the total interest paid over time.
What Should You Do Now?
If you are a saver, this is a good time to keep an eye on FD rates offered by different banks, especially if you have deposits nearing maturity. You might consider a strategy called 'laddering'—splitting your investment into FDs with different maturity dates to take advantage of potential future rate changes. For borrowers with floating-rate loans, the first step is to check with your lender about how the rate hike will be implemented for your specific loan. If your budget allows, consider making partial prepayments towards your principal. Even small, regular prepayments can significantly reduce your total interest outgo and shorten your loan tenure. Another option could be to increase your EMI amount voluntarily to pay off the loan faster.
