Should home seekers put off buying a house because of high interest rates?

The series of rate hikes has resulted in the EMI on home loans going up by more than 20% to Rs1,016 on every one lakh rupees. However, with rates having climbed so high, it would not be wrong to assume that any further increases should be very limited

The past 12 months have seen interest rates on home loans rise from 8% to 10.75%. This has resulted in equated monthly installments (EMI) going up by 21% from Rs837 for every one lakh rupees on the loan to Rs1,016. The question facing home buyers today is whether to go ahead and buy a house if and when real estate prices do decline, or wait till interest rates drop too. Before we answer that, let us understand why interest rates increase or decrease and what the long-term implications are for home buyers.

Interest rates in India are largely a function of the monetary policy, which is decided by the Reserve Bank of India (RBI). The RBI has several goals; the most difficult of them is to maintain a balance between the need to ensure economic growth and control inflation. When inflation rises and threatens to spin out of control, as it has today, the RBI 'tightens' monetary policy. This amounts to reducing, or making expensive, the money supply in the economy.

The RBI achieves this by either increasing the repo rate (the rate at which banks borrow from the RBI) which increases borrowing costs, or increasing the cash reserve ratio (CRR) which has the effect of reducing money supply in the economy. Though the RBI's policies could take up to a year to have their full intended impact, they are perhaps the most effective way to reduce inflation.

The RBI has increased repo rates nine times in the past 12 months, from 5.25% to 8%, towards curbing stubborn inflation. This has resulted in an increase in the base rates of banks and the prime lending rates (PLR) of housing finance companies by 2.5%-3%. Consequently, home loan rates have increased from around 8% per annum to 10.75% and the EMI has shot up by 21%.

This increase in EMI impacts buyers' budgets and often persuades them to wait for the interest rates to come down. As almost all home loans are offered on a floating rate basis, the interest rates applicable would increase in line with rising interest rates. This would mean that even if you had taken a loan at 8%, the current rate would be 10.75%, and either the EMI would have gone up or the tenor (repayment period) of the loan would have increased. Clearly, home-buying decisions should not be influenced by the level of interest rates prevailing at the time of the purchase of house.

However, there are long-term implications for home buyers who take a mortgage, since interest rates are cyclical in nature (illustrated below by repo rate movement over the past six years).

Interestingly, when interest rates are high, there is a smaller probability of a further increase in the interest rate, and thereby a lesser risk of the burden of an increase in EMI. Conversely, in a low interest rate environment, the risk of a subsequent increase in interest rates, leading to a bigger EMI burden is higher.

The correct strategy, especially in a low interest rate environment, would be to assume that interest rates can go up by as much as 2%. Interest rates have averaged 10% over the past 10 years for home loans and hence the assumption of a 10% interest rate is a good thumb rule to calculate your repayment capacity.

The tax benefit available on housing loans is an important consideration since it reduces the effective cost of borrowing. As illustrated (below), the effective cost of borrowing is still below 8% for an average home buyer.

In conclusion, current high interest rates should not deter one from buying a house, but it would be wise to keep some cushion in one's borrowing capacity, to provide for increases in interest rates and the consequent increase in EMI.

(Gagan Banga is a writer and CEO of Indiabulls.)




5 years ago

this information is very useful for home loan tatker

Govind Shanbhag

5 years ago

Gagan jee - Buying a house for many is an impulsive decision. For the last 2-3 years I have been hearing the rate is coming down which has not happened. Many of house buyers they dispose off existing house buy a new one, adding extra space, room and/or in improvement in area. In such an event, the house which they are now disposing off will also command lesser rate. One thing is sure, due to slow down in redevelopment of old buildings, the rentals in suburb has come down marginally.

Samarth Singh

5 years ago

The writer does not take into consideration the purpose behind the purchase of a house i.e. whether it is an investment or a first-home purchase.

The reasons for a first-home purchase can be numerous and the timing is really dependant on personal reasons, preferences, needs and wants.

In the case of a purchase made as an investment - the interest rate environment is irrelevant. What really matters is the expected yield on the investment. A purchase made at a higher than normal yield will be reflected in substantial capital gains in the future and vice versa.

A high interest rate environment simply increases the possibility of being able to purchase a property (or any other asset for that matter) at an attractive rental yield.

Another way to think about this is if you consider purchasing a piece of real estate as investment without a mortgage. In this case, interest rates are irrelevant to you. The only thing that should matter is if you are getting a good return (in terms of rental yield) on your investment vis-a-vis other investment opportunities available to you.

On another note - as I have mentioned above, a good return on investment should be measured by rental yield and not by at what price you expect to sell to the next fellow. The greater fool's theory (i.e. let me buy today because a greater fool is going to buy from me at a higher price tomorrow) is a fine form of speculating but not an intelligent form of investing.

Govt likely to soon approve SBI capital infusion

The finance ministry received a proposal from SBI in this regard a few weeks ago, sources said, adding that it is being examined and a decision will be taken shortly. As per the proposal, SBI requires Rs20,000 crore to fund its growth plans over the next two fiscals

New Delhi: The government is expected to provide capital support to the country's largest lender State Bank of India (SBI) during the current fiscal and a decision in this regard will be taken soon, reports PTI.

"We will capitalise SBI adequately so that the Tier-I capital is maintained over 8%, in line with the government's intent," official sources told PTI.

The finance ministry received a proposal from SBI in this regard a few weeks ago, sources said, adding that it is being examined and a decision will be taken shortly.

As per the proposal, SBI requires Rs20,000 crore to fund its growth plans over the next two fiscals.

Based on the proposal, sources said, various possibilities are being looked at for the capital infusion. It could be by way of a rights issue, preferential share issue, warrants, etc.

It is too premature to comment on the exact mechanism for the capital infusion, as all the options are still being explored, the sources said.

The government is committed to providing adequate capital to all public sector banks so as to maintain their Tier-I capital at 8% and the government's stake over 58%, sources added.

As of June, 2011, the Capital Adequacy Ratio (CAR) of SBI stood at 11.6%. Of this, Tier-I capital stood at 7.6% at the end of first quarter, against the minimum 8% level desired by the government.

Earlier this month, SBI chairman Pratip Chaudhuri had said, "We are already in a dialogue with the government for the rights issue to bring new Tier-I... It should happen by the end of this fiscal."

The government is committed to maintaining the public sector character of the bank and after amendment of the State Bank of India Act, the percentage of government holding cannot go below 51%, he had said.

"So in various scenarios, what would be the requirement of the rights issue, what would be contribution required for the government? The number would be as high as Rs14,000 crore to Rs9,000 crore," he had said.

"Rs 14,000 crore if it retains at 59%, Rs9,000 crore for 51% and Rs11,000 crore for 55%," he added.

Currently, the government has a 59.4% stake in the bank. In case a rights issue is approved and the government wants to retain its holding at the current level, it would need to subscribe to 59.4% of the total rights being issued.

It is to be noted that the country's largest lender had raised over Rs16,000 crore through a rights issue in 2008. In the last SBI rights issue, the government contribution was in the form of bonds to the bank instead of cash.


Gold drops further by Rs700, silver sheds Rs1,700

Trading sentiment was dampened in global markets as some investors offloaded their holdings of the precious metal after CME, the world's largest futures market, increased the margin requirement for futures transactions

New Delhi: Gold and silver registered their biggest single-day decline in 18 months in the bullion market here in the Indian capital city Friday on frantic selling by stockists, triggered by a meltdown in global markets, reports PTI.

Gold plunged by Rs700 to Rs27,140 per 10 grams, while silver tumbled by Rs1,700 to Rs62,500 per kg, following the precious metal's steepest decline in more than three years in overseas markets.

In global markets, gold nosedived by 7.5% to $1,723.70 an ounce from its record high of $1,913.50 an ounce on Wednesday, the biggest drop since March 2008.

The trading sentiment was dampened in global markets as some investors offloaded their holdings of the precious metal after CME, the world's largest futures market, increased the margin requirement for futures transactions.

The minimum amount of cash that speculators must deposit for futures trade in gold was raised by 27% per 100 ounces of the shiny metal on the CME.

Stockists in the Delhi bullion market-which was closed Thursday in support of Anna Hazare's fast demanding a strong Lokpal Bill-indulged in heavy selling in tandem with melting global markets.

In addition, demand from retailer customers has dried up at existing high levels, which further influenced the market sentiment.

In the national capital, gold of 99.9% and 99.5% purity dropped by Rs700 each to Rs27,140 and Rs26,990 per 10 grams, respectively.

Sovereigns lost Rs300 to Rs22,200 per piece of eight grams.

Likewise, silver ready plunged by Rs1,700 to Rs62,500 per kg and weekly-based delivery shed Rs1,525 to Rs62,090 per kg.

Silver coins also tumbled by Rs3,000 to Rs68,000 for buying and Rs69,000 for selling of 100 pieces.


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