First, What Are Basis Points?
Before we dive into the impact, let's decode the terminology. A 'basis point' is a common unit of measure in finance. One basis point is equal to one-hundredth of a percentage point (0.01%). So, a 25-basis-point increase means the interest rate has gone
up by 0.25%. Financial experts use this term to avoid ambiguity. This change is usually applied to the 'repo rate' – the rate at which the RBI lends money to commercial banks. When this rate changes, it creates a ripple effect across the entire banking system, influencing the interest rates that banks offer you.
Your Loans Will Cost More
The most immediate and noticeable effect of a rate hike is on borrowing costs. If you have a floating-rate loan, such as a home loan linked to an external benchmark like the repo rate, your interest rate is likely to go up. When banks' borrowing costs from the RBI increase, they typically pass it on to customers. This could mean either your Equated Monthly Instalment (EMI) will increase or your loan tenure will get longer. For example, on a ₹50 lakh home loan with a 20-year tenure, a 0.25% rate increase (from 8.00% to 8.25%) could increase your monthly EMI by around ₹780. While this might seem small, it adds up over the life of the loan. Personal loans and auto loans with variable rates will also be affected, making new borrowing more expensive.
A Silver Lining for Savers
It's not all bad news. For savers, a rising interest rate environment can be beneficial. To attract more funds, banks often increase the interest rates they offer on Fixed Deposits (FDs). A higher repo rate generally translates to higher returns on new FDs. This encourages people to save more. However, it's important to note that this increase applies to new FDs or those up for renewal. The interest rate on your existing FDs will remain locked in until maturity. So, if you were planning to open an FD, a rate hike cycle could be an opportune time to lock in a higher return.
The Impact on Credit and Spending
A rate hike is one of the RBI's primary tools to control inflation. By making borrowing more expensive, it aims to reduce the amount of money circulating in the economy, thereby cooling down demand for goods and services. This also affects credit card users. Most credit card interest rates are variable and can increase following a repo rate hike, making it more expensive to carry a balance month-to-month. The overall goal is to encourage saving over spending, which helps in managing price rises across the economy.
Your Financial Strategy Now
A 25-basis-point hike is a signal to review your finances, not to panic. If you have high-cost debt like credit card balances or expensive personal loans, prioritize paying them down. For home loan borrowers, check with your lender. Some may allow you to increase your EMI to keep the original tenure intact. If you have surplus cash, consider making a partial prepayment on your principal to reduce your interest burden. For investors, this is a good time to look at your portfolio. Short-term debt funds are generally less affected by rate hikes than long-term ones. You might also consider laddering your FDs—splitting your investment into multiple deposits with different maturity dates—to balance liquidity and take advantage of potentially rising rates.
