Indiabulls Housing Finance head explains that increasing the EMI is better than extending the loan tenor

The corporate sector had hoped otherwise, but the Reserve Bank of India (RBI) today hiked key interest rates by a further 25 basis points. This will likely make home and automobile loans still more expensive and realtors believe that property prices will go up further. In this situation, Sachin Chaudhary, business head of Indiabulls Housing Finance, has advised borrowers not to go for fixed-rate loans or to extend loan tenors.

"In a high rate scenario, try and increase your EMI if your pocket allows. Do not go for fixed rate loans, because the rates are expected to soften," Mr Chaudhary said. He also argued that it was preferable to keep the tenor constant than to pay a fixed amount of EMI. In the latter case, the interest increases significantly by the time the loan is repaid. "Don't increase the loan tenor," he said.

The Indiabulls Housing Finance head also explained that in the case of a fixed tenor the effective rate is much lower, because deductions on home loans result in tax benefits. He demonstrated this through an example: When the tenor is fixed for 180 months, and if rates are hiked by 0.25% with each successive EMI payment, even though the EMI amount on every Rs1 lakh increases, the overall increase in rate of interest after six successive hikes is 9%. However, when the EMI is fixed and the tenor keeps on increasing by even one month, after six extensions, the interest rate is increased by 22%.

Mr Chaudhary advised that in the present situation, it was better to renegotiate the rate of interest rather than switch to another financial institution. He also said that prepayment was the best option, and a part prepayment could reduce the loan tenor up to 50%.

Most banks offer loans that have tenets of 'teaser loans', that is a fixed rate for the first few years and then at par with floating rate loans. Experts think that the interest rate hikes are nearing their peak, and a lock in for 3-5 years is not advisable. "In most cases, the fixed-floating hybrid loans favour the lender and not the buyer," said an analyst.

The RBI today announced a hike in interest rates, the 12th time it has increased rates since March 2010. Repo rate now stands at 8.25% and the reverse repo rate at 7.25%.

Indian Overseas Bank chairman and managing director M Narendra said, "I believe banks will wait till the month-end before taking a call on an interest rate hike." Bankers are of the opinion that the rate increase will be passed on to customers sooner than later.