With the skyrocketing home loan rates, the equated monthly instalments (EMIs) of the existing loans have also increased manifold, potentially disrupting people's household budgets. However, there may still be a solution to get around this problem by focusing on the loan interest spread.
A recent study by BankBazaar shows that the interest rate spreads on home loans have fallen to new lows, presenting an opportunity for homeowners to tackle the problem.
The interest rate on every retail loan has two components: the benchmark rate and the spread. While the spread varies from borrower to borrower, it remains constant for the loan period. The spread is calculated based on the borrower's credit score, income source, and loan size.
For example, it explains that if a salaried borrower has a credit score of 750, considered good, the interest spread will be 2.50 over the repo rate. So, the final interest rate will be 6.50 + 2.50 = 9.00.
Currently, the Reserve Bank of India's (RBI) repo rate is at 6.5 per cent, the rate at which commercial banks avail loans from the central bank. The current repo rate is significantly high, given that banks benchmark it to reset the rates on their existing home loans accordingly. Say if the repo rate rises by 25 basis points to 6.75, the loan rate will change by an equal measure to 9.25.
The BankBazaar report, however, notes that home loan spreads have been falling year after year. It said that "the lowest spreads on home loans stood at 1.95 in March 2023, steadily falling from the nearly 3.50 prevalent in March 2020." The report highlights the complexities homeowners must understand arising from higher rates with falling spreads.
Floating Rate Home Loans
Inflation, repo rate changes, and the lender's policies could influence home loan rates. For example, bank home loan rates are reset by the same margin as the changes in the repo rate.
The study stresses that "exploiting these rate differences could help them save lakhs of rupees on outstanding loans in a high-inflation scenario.
Credit-Worthy Borrowers Get The Lowest Rate
The most credit-worthy borrowers with high credit scores and stable income generally get the lowest rate or spread. "While rates fluctuate, borrowers retain the spreads they had purchased the loan with. These complexities mean that new borrowers are at an advantage over old borrowers," says the study. So, borrowers can "lock into a lower spread now and pay less compared to a pre-pandemic borrower who may be paying a substantial premium over the market rates."
In this case, a simple solution could be a loan refinance, either from the same lender or a different one. However, the refinancing cost could be much less from the same lender than a new one in terms of processing fees and paperwork, etc.
