Repo rates directly influence home loan interest rates, affecting EMIs and loan costs. Understanding this link helps customers make informed decisions, manage repayments, and optimise home loan affordability. So, what is repo rate, what are its long-term effects, and how does it affect home loan rates? Read along to know more.
What is the Repo Rate?
The Repo Rate is the rate of interest at which a country's central bank (for instance, the Reserve Bank of India) lends money to commercial banks when they face a shortage of funds.
This rate is a key monetary policy tool used to regulate inflation and liquidity in the economy. An increase in the repo rate means borrowing is more expensive, which helps to bring down inflation. When the repo rate is lower, however, borrowing is encouraged, and economic activity is boosted.
How Does the Repo Rate Affect Home Loan Interest Rates?
The repo rate indirectly affects interest rates on home loans since it is the cost at which banks borrow from the Reserve Bank of India (RBI). When the repo rate is increased, banks may adjust lending rates to align with the revised borrowing costs. This can result in changes to home loan interest rates or EMIs, particularly for borrowers with floating-rate loans.
Conversely, lowering the repo rate reduces borrowing costs for the banks, encouraging them to reduce interest rates on home loans, effectively making the EMIs cheaper or reducing the loan duration.
For new home loan borrowers, an increased repo rate means a costlier loan, while a reduced rate means cheaper loans. Floating-rate home loans are directly linked to the repo rate (the interest rate at which the central bank lends to banks) and thus rise or fall with it, while fixed-rate loans remain static until they are refinanced.
These analytics are crucial in determining whether a borrower can commit to a loan, which is particularly critical during volatile interest rate periods. Now, it is important to understand how the change in this rate impacts your EMIs.
How a Change in Repo Rate Impacts Your EMI?
Repo rate change directly affects the home loan EMIs, especially in the case of floating-rate loans. When the Reserve Bank of India (RBI) raises or cuts the repo rate, banks revise their lending rates, and consequently, borrowers have to pay more or less at the month's end.
Note: The RBI has kept the repo rate unchanged at 6.5% w.e.f. January 14, 2025. If you have a home loan of ₹60 lakh with a tenure of 20 years at an interest rate of 8.5%, then your current EMI would be around ₹52,000. If the interest rate is increased due to a repo rate hike to 9%, EMI would rise to around ₹54,000, increasing the monthly outflow.
In some scenarios, instead of raising the EMI, they may offer to extend the loan tenure, which would stretch the repayment period, keeping the EMI the same but leading to much more interest paid across the lifetime of the loan.
However, financial institutions usually inform borrowers about any change in EMIs or tenure so that they can plan their repayments accordingly. Knowing such dynamics can enable borrowers to effectively prepare for and cope with interest rate fluctuations.
The Impact of Repo Rate on Home Loan Approvals
The Reserve Bank of India's (RBI) repo rate directly influences home loan approvals in several ways:
- Credit Availability: An increased repo rate raises banks' borrowing costs, leading them to be more selective in lending, which can result in stricter home loan approval processes.
- Borrower Eligibility: Higher interest rates can affect borrowers' debt-to-income ratios, potentially making it more challenging for them to meet eligibility criteria for loan approvals.
- Economic Conditions: Elevated repo rates aim to control inflation but can also slow economic growth, indirectly impacting borrowers' repayment capacities and influencing banks' lending decisions.
Understanding these factors is crucial for prospective homebuyers navigating the loan approval process.
Long-Term Effects of Repo Rate on Home Loans
The repo rate on home loans, set by the Reserve Bank of India (RBI), significantly impacts home loans over the long term. When the RBI hikes the repo rate, banks have to pay more when borrowing money, forcing them to hike interest rates on home loans.
This means higher EMIs for the borrower. If the loan tenure is long, then the EMIs will result in a heavy financial burden over time. Whereas a reduction in the repo rate lowers the cost of borrowing for banks, which can lower sectoral loan rates such as home loans and can reduce EMIs as well.
Over the long term, even a slight change in the repo rate can make a huge difference in the cost of the loan. If interest rates keep rising, borrowers might pay more in interest over the life of the loan. Borrowers should monitor repo rate changes and update their repayment strategies as they occur.
How to Protect Yourself from Repo Rate Fluctuations?
Follow the tips below to protect yourself from repo rate fluctuations –
- Opt for Fixed-Rate Loans: Choose a fixed-rate home loan to keep EMIs stable, unaffected by repo rate changes.
- Prepayment of Loan: Regularly make prepayments to reduce the principal, thus lowering the interest burden.
- Increase Loan Tenure: In case of rising rates, you can extend the tenure to keep EMIs affordable.
- Refinance Loan: Refinance your loan when favourable rates are available, especially if the repo rate decreases.
- Monitor Repo Rate Trends: Stay updated on the repo rate changes to make timely decisions on your loan.
- Maintain a Good Credit Score: A higher credit score can help you secure better rates, reducing the impact of rate hikes.
Repo Rate Trends in India
Over the past five years, India's repo rate has seen a steady increase. From 4% in May 2020, it rose to 6.50% in December 2024, reflecting efforts to combat inflation. The Reserve Bank of India made frequent adjustments, particularly from 2022 to 2024, with rates increasing by 0.5% gradually.
The most significant jump occurred in 2023, when the rate rose from 6.25% to 6.50%. This hike was largely driven by inflation control measures, as RBI aimed to curb excessive money supply. The repo rate is crucial for managing liquidity and controlling inflation, impacting loans, FD rates, and economic growth.
Wrapping Up
Understanding the repo rate helps in making informed decisions about home loans. It directly affects interest rates, EMIs, and eligibility. Stay updated on trends and explore options like PNB Housing Home Loans to manage rate changes.
FAQs
What happens to my existing home loan if the repo rate changes?
If you have a floating-rate loan, your EMI may increase or decrease based on the repo rate changes, affecting repayment amounts.
Why does the RBI change the repo rate?
The RBI adjusts the repo rate to control inflation, regulate liquidity, and stabilise the economy, influencing borrowing costs and economic activity.
How does a repo rate hike affect new homebuyers?
A repo rate hike increases home loan rates, leading to higher EMIs and overall loan costs for new homebuyers.
