High interest rates may encourage pre-payment of a home loan
By Vaibhav Aggarwal
Sep 18, 2008
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At a time when interest rates are shooting through the roof, most of the home loan borrowers are confused about the repayment of their loan.

To keep inflation under check, Reserve Bank of India has hiked short-term lending rate (REPO) five times and mandatory cash deposits that commercial banks have to keep with the central bank 13 times since January 2007. These hikes in CRR and REPO rate have drained out about Rs 8,500 crores from the banking system and in turn raised the lending rates of the banks.

The hikes in housing loan rates have upset the calculation of most of the borrowers. The interest rates in this segment have risen to 12 percent from 7 percent in the recent past and thereby the EMI installments have also gone up.

These hikes have witnessed an increase in the number of borrowers asking banks for foreclosures and partial repayments. However one needs to realize the impact of such a decision. Foreclosure or partial payment could affect the liquidity adversely in the short to medium terms.

Foreclosure/Partial Repayments is the legal proceeding in which a mortgagee, usually a lender, obtains a court ordered termination of a mortgagor's equitable right of redemption.

Most of the home loan borrowers are now opting to reduce their loan tenure which has been extended due to the hikes in interest rates. These borrowers are the ones who have taken their loans under the floating rates and are running fast to make huge payments.

In fact many borrowers are deciding to make a pre-payment for their home loan as the EMI have gone up. But it is advisable to calculate the net cost of the home loan before arriving to a decision. This can be done by factoring in the income tax benefit on the housing loan interest.

In case the pre-payment of a loan is done through refinancing facility, a borrower has to pay a penalty to the bank. At the same time if the loan is repaid from the borrower's own pocket, no charges are levied by the banks.

With interest rates on home loans rising in the last one year, people are now looking at other options to invest their funds. Speculators have kept themselves away from the real estate market. This indeed may be advantageous to the buyers as it will prevent speculators from over-leveraging themselves for speculative gains.

Although the housing finance regulator, National Housing Banking (NHB) predicts the home loan rates to decline from early 2009. S. Sridhar, Chairman and Managing Director of the NHB, said, "Interest rates are likely to come down from January and we expect the home loan rates to fall after that."

"We expect home loans to stabilize to around 10 percent in the near term," added Mr. Sridhar.

Yet the decision for pre-payment of a loan falls on an individual alone.

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