RBI monetary policy: Ladder your FDs and benefit from higher rates later

Home loan borrowers must pre-pay to prevent their loan tenures from rising

With the Reserve Bank of India (RBI) governor himself stating that rate hike in June is a no-brainer, the focus was on the quantum of the hike. The central bank has answered that question by going in for a repo rate hike of 50 basis points. This rate now stands at 4.90 per cent. Altogether, the central bank has hiked this benchmark rate by 90 basis points in the current rate-hike cycle.

Implications for depositors

Usually, the increase in bank deposit rates is not in sync with the repo rate hike by the central bank. Generally, banks hike their deposit rates by a lesser amount. After the 40-basis point hike in May, banks had hiked rates by 20-30 basis points on an average. They do so in order to keep a check on their cost of funds.

With inflation continuing to remain high, more rate hikes are expected in the near future.

“Investors who have a lump sum amount should deposit it in a fixed deposit of three-six months. Once these deposits mature, they can consider locking into FDs of longer tenure, depending on where deposit rates are at that point,” says Adhil Shetty, chief executive officer, BankBazaar.com.

Most experts are of the view that locking into a longer-tenure FD currently would be a mistake.

If after six months, you feel that deposit rates have peaked, you may lock into FDs of one or two years.

Those who have larger sums should ladder their investments. If you have, say, Rs 3 lakh to invest, then invest Rs 1 lakh in a three-month FD, another Rs 1 lakh in a four-month FD, and another Rs 1 lakh in a six-month FD. This way you will have money coming in at regular intervals. Instead of trying to guess whether you are at the peak, you can reinvest in a staggered manner and try to average out the returns on the higher side.

What should borrowers do

Most longer-tenure loans, such as home loans, are floating-rate loans. A very small percentage of home loan borrowers today are on fixed-rate loans. And even there, the rates would be fixed for a limited tenure, of two-three years, after which they are liable to reset. Fixed-rate customers would also be paying a 2-3 percentage point higher rate than floating-rate customers.

Shorter-tenure loans like auto loans and personal loans are likely to be at a fixed rate.

“Borrowers who are feeling the pinch of home loan EMIs should look to prepay the loan out of the savings they have. If their earnings have gone up over the past couple of years, they may also hike their EMI so that their tenure remains unchanged,” says Arvind A Rao, certified financial planner and founder, Arvind Rao and Associates.

According to Shetty, customers should target prepaying at an optimal rate of 5 per cent of the principal outstanding annually.

In these difficult times, borrowers must also keep an eye on their credit score. “If your credit score has deteriorated since the time you took a loan, the lender reserves the right to hike your home loan rate,” says Shetty.

Key points to remember

·  More rate hikes are likely, so avoid locking into longer-tenure FDs

·  It is best to opt for 3-6-month FDs at present

·  Those with larger sums should ladder of their investments so that their FDs keep maturing at regular intervals, and they can average out the returns on the higher side

·  Home loan borrowers should try to prepay their loans to prevent the tenure from rising

·  Keep a close eye on your credit score: If it deteriorates, the lender reserves the right to hike your rate