Home Loan: New RBI Rules Can Help You Save Rs 33 Lakh in Interest in a Rs 50-Lakh Loan

By MakeMyMoney

September 27,2023

Introduction

The Reserve Bank of India (RBI) has recently introduced new rules that can potentially save home loan borrowers a significant amount of money in interest payments. Traditionally, when the interest rates increase, banks would extend the tenure of the loan to protect borrowers from rising equated monthly installments (EMIs). However, this extension often leads to higher overall interest payments and longer durations of debt for borrowers. To address this issue, the RBI has mandated lenders to provide borrowers with options to either increase the EMI, extend the loan tenure, or use a combination of both when resetting interest rates on home loans. In this article, we will explore the new RBI rules and how they can benefit home loan borrowers.

The Usual Norm: Hiking EMIs or Extending Tenure?

In the past, when interest rates rose, lenders typically chose to extend the loan tenure instead of increasing the EMI. This practice aimed to shield borrowers from immediate hikes in EMIs. However, borrowers often end up paying a substantial amount of money towards interest payments due to the extended tenure. Longer loan tenures result in higher overall interest payments, and borrowers remain in debt for a more extended period.

New RBI Mandate on Home Loans

To address the challenges faced by borrowers due to extended tenures, the RBI released a notification on August 18, 2023, outlining new repayment rules. These rules provide borrowers with more options and control over their home loans. The key highlights of the RBI's new mandate are as follows:

Communication of Impact: Lenders are required to communicate to borrowers the potential impact of changes in benchmark rates on EMIs, tenure, or both.
Switching to Fixed Rate: Borrowers should be given the option to switch from floating to fixed interest rates, with all applicable charges disclosed in the loan sanction letter.
Options for Borrowers: Borrowers should be given the choice to extend the loan tenure, increase EMIs, or both.
Preventing Negative Amortisation: Lenders must ensure that extending the tenure does not result in negative amortisation, where monthly loan payments are insufficient to cover accruing interest.

These new rules ensure that lenders cannot unilaterally make decisions that significantly impact borrowers without their consent or consideration of their financial situations.

How the New RBI Rules Benefit Home Loan Borrowers

The new RBI rules provide borrowers with more flexibility and control over their home loans, enabling them to make informed decisions based on their financial circumstances. Let's consider an example to understand how these rules can benefit borrowers:

Suppose a borrower starts a home loan of Rs 50 lakh at a 7% interest rate for 20 years. After three years, the interest rate increases to 9.25%. Under the new RBI rules, the borrower has the option to either increase the EMI, extend the loan tenure, or use a combination of both.

Scenario 1: Increasing EMI and Maintaining Loan Tenure

If the borrower chooses to finish the 20-year loan within the remaining 17 years (considering 3 years have passed), the EMI will increase to Rs 44,978 per month. At the end of the loan tenure, the borrower will pay a total interest of Rs 55.7 lakh.

Scenario 2: Extending Loan Tenure and Maintaining EMI

Alternatively, if the borrower decides to maintain the EMI at Rs 38,765, the loan tenure will extend to 26 years and 10 months. In this case, the borrower will pay a total interest of Rs 88.52 lakh, resulting in an additional interest payment of Rs 33 lakh compared to Scenario 1.

These examples illustrate how the new RBI rules empower borrowers to choose the option that best suits their financial goals and capabilities. By considering the impact of interest rate changes and providing flexibility in EMI and tenure adjustments, borrowers can potentially save a significant amount of money on interest payments.

Factors to Consider When Choosing Between EMI and Tenure Adjustments

When deciding whether to increase the EMI or extend the loan tenure, borrowers should consider the following factors:

Affordability: Increasing the EMI should not strain the borrower's financial resources. It is essential to ensure that the higher monthly payout remains manageable within the borrower's repaying capacity.
Budget Flexibility: Extending the tenure can provide borrowers with more breathing room in their monthly budgets. However, it is crucial to evaluate whether this option aligns with long-term financial goals, as it may result in higher interest payments over the loan tenure.
Prepayment Strategies: Prepaying a portion of the loan can help reduce overall interest outgo. Borrowers should consider utilizing windfall gains or annual bonuses to make prepayments, as this can significantly reduce the loan balance, interest charges, and EMIs.
Income Growth: If the borrower's income increases over time, opting for an increase in the EMI amount can accelerate loan repayment and reduce the overall interest paid.

By carefully evaluating these factors and consulting with financial advisors, borrowers can make informed decisions that align with their financial goals and capabilities.

Conclusion

The new RBI rules on home loans offer borrowers greater flexibility and control over their loan repayments. By providing options to increase the EMI, extend the loan tenure, or use a combination of both, borrowers can make choices that align with their financial circumstances and goals. It is essential for borrowers to consider their affordability, budget flexibility, prepayment strategies, and income growth when deciding between EMI and tenure adjustments. By making informed decisions, borrowers can potentially save a significant amount of money on interest payments and achieve their homeownership goals more efficiently.