Prepay at least 5% of your home loan each year to tackle rising rates

With rates cuts unlikely anytime soon, debt mutual fund investors should avoid duration calls

The Reserve Bank of India (RBI) hiked the repo rate by 25 basis points in its monetary policy review of February 8. The repo rate now stands at 6.5 per cent, up 250 basis points since the start of the rate hike cycle in May 2022.  

Most experts believe we have reached the terminal rate in the current rate hike cycle. However, there are a few caveats. Says R Sivakumar, head-fixed income, Axis Mutual Fund: “While we believe we are at the peak of policy rates, inflation and US Federal Reserve action can be wild cards for market participants.”

Many market participants had expected the policy stance to change to neutral. That did not happen. The policy statement also did not mention a pause in rate hikes. All this indicates caution on the RBI’s part.

“RBI governor Shaktikanta Das made references to sticky core inflation again in this review, as he had done in the previous one,” says Joydeep Sen, corporate trainer (debt markets) and author. He adds that while further rate hikes look unlikely, the RBI has retained the option to do so if required.  

Consumer price index (CPI)-based inflation had come in at 5.72 per cent in December. This was within the RBI’s comfort zone but substantially above its target rate of four per cent. “By hiking rates and not committing to a pause in rates, the RBI is indicating its commitment to bring CPI inflation to the four per cent band,” says Murthy Nagarajan, head-fixed income, Tata Mutual Fund.

Expect rates to remain elevated for some time. “Given that the projection of CPI inflation for next year remains above the 5 per cent level in, the chance of rate cut looks remote,” adds Murthy.

Existing borrowers: Pre-pay home loan

Existing borrowers should be prepared for their equated monthly instalments (EMIs) to go up after the latest repo rate increase. “Banks’ ability to assist borrowers is limited as loan term extensions have already been exhausted for most borrowers,” says Anuj Sharma, chief operations officer, IMGC.

Naveen Kukreja, chief executive officer (CEO) & co-founder, Paisabazaar points out that opting for an increase in EMI is better than allowing your tenure to balloon as the latter option can raise your cumulative interest cost significantly.  

The best way to control rising borrowing costs is to prepay the loan. “Try to prepay 5 per cent of your principal outstanding every year. This is quite feasible. Prepaying this much each year can bring down your tenure by almost seven years for a 20-year loan,” says Adhil Shetty, CEO, BankBazaar.com. Alternatively, you could pay one additional EMI each quarter or at least two-three more EMIs each year, depending on your cash flows and the prepayment conditions of your lender.  

If your credit score has improved, opt for a home loan balance transfer. “Your improved credit profile may make you eligible to transfer your existing home loan to another lender at a much lower rate,” says Kukreja.

New borrowers: If you can afford it, go for it

The latest repo rate hike will add to new buyers’ financial burden. “Apart from home loan interest rates, property prices have also inched up in the past two to three quarters,” says Anuj Puri, chairman, ANAROCK Group. He expects buyers of mid-range and affordable housing to be affected the most.

Sharma says increasing interest rates will also make it difficult for a larger number of customers to qualify for mortgages.

Those who take a home loan now will enter at (perhaps) peak rates. The silver lining in the situation is that the interest-rate cycle will turn eventually, say, in a year or two. That means new borrowers will repay a good part of their loans at lower rates. “By making a few planned pre-payments in a lower rate scenario, new borrowers will be able to bring down their borrowing cost significantly,” says Shetty.

FD investors: Lock-in for 12-15 months  

Existing fixed deposit (FD) investors should continue with their current FDs till maturity. “Opt for premature FD closure only if you find a significant gap between the new FD rates and the rates on your existing FDs after accounting for premature withdrawal penalty,” says Kukreja.

Shetty suggests locking in rates for 12-15 months currently. “Rates will probably be at the peak at the end of this period,” he says. If you get good returns in special-rate FDs (for terms like 400 or 730 days), go for them.

Compare FD rates among as many banks as possible. “Currently small finance banks (SFBs) and some private-sector banks are offering the highest FD slab rates of 7.5 per cent per annum or above,” says Kukreja.

SFBs also come under the Depositor Insurance Program, which covers a depositor for up to ~5 lakh in each bank. Make sure all your deposits in a bank don’t exceed ~5 lakh. Financial planners suggest not putting in more than 20-25 per cent of your total FD corpus in SFBs.

Debt MF investors: Invest based on horizon

While corporate bond yields may inch up, this is likely to happen very gradually. “We think bond yields are close to peak and are at attractive levels, so investors should lock into current yields,” says Alekh Yadav, head of investment products, Sanctum Wealth.

Select debt mutual categories based on your investment horizon and risk appetite.

Those with a horizon of up to one year should opt for categories like liquid, ultrashort, low duration and money market funds. Those with a three-year horizon may opt for short duration funds, corporate bond funds and banking and PSU funds.

“If you have a longer horizon, opt for a target maturity fund whose maturity date matches your investment horizon,” says Sen.

He suggests avoiding duration calls right now. “As the yield curve is flat, you won’t get adequately higher yield for moving from a maturity of five years to 10 years,” he says.

Most experts believe rate cuts are some time away, so you are unlikely to get the benefit of mark-to-market gains by entering longer-duration funds at present.