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Financial challenges may increase in the times to come for the country’s middle class and crores of borrowers who take loans from banks and buy houses or cars. Amid rising inflationary pressure in the global and domestic markets, high crude oil prices and the stance of the US Federal Reserve, major brokerages and financial rating agencies have predicted that the Reserve Bank of India (RBI) may resume the cycle of increasing interest rates in the upcoming monetary policies. According to recent analytical reports, the central bank’s repo rate may increase by 75 basis points to reach the level of 6.00% during the second half of the current financial year and the upcoming financial year 2027 (FY27). If this estimate proves to be true, then the External Benchmark Lending Rate (EBLR) will be directly increased by the banks, which will lead to a sharp jump in the monthly installment i.e. EMI of home loans, auto loans and personal loans running on floating rates.
The biggest challenge currently facing the Monetary Policy Committee (MPC) of the Reserve Bank is to keep inflation close to the target of 4 percent. Due to the continuous rise in international crude oil prices and pressure on the Indian rupee against the dollar, the threat of imported inflation remains constant. Apart from this, inflation in the food and services sector in the country has also registered an increase in recent months. Financial analysts believe that if headline CPI inflation remains above 5 percent amid strong GDP growth, the RBI may be forced to raise rates to maintain economic stability and balance the rising pressure on government bond yields. The report said that the central bank can increase the interest rates in installments of 25-25 basis points from the current level of 5.25% to the range of 5.75% to 6.00%.
As per RBI rules, all new retail loans (like home loans and auto loans) offered by banks after October 2019 are mandatorily linked to an external benchmark, called the Repo Linked Lending Rate (RLLR) or EBLR. Its simple and practical meaning is that as soon as RBI increases its policy repo rate by 0.25% or 0.50%, commercial banks (like SBI, HDFC Bank, ICICI Bank, PNB etc.) increase their loan interest rates by the same amount within a few days. Its most immediate impact is on floating rate borrowers. As the interest rate increases, either the monthly EMI of the customer increases, or the banks extend the tenure of the loan by several months or years, due to which the total interest burden becomes heavy.
If there is a total increase of 75 basis points (0.75%) in the repo rate, then how it will affect the pocket of the common borrower can be understood with a simple financial example. Suppose a customer has taken a home loan of ₹30 lakh at an interest rate of 8.50% for a tenure of 20 years. Currently his monthly EMI works out to be around ₹26,035. If banks increase the interest rate by 0.75% to 9.25%, the same EMI will increase to ₹27,476 per month. This means that every month there will be a direct additional expense of approximately ₹ 1,441 out of pocket. Over the entire tenure of 20 years, this seemingly small difference adds up to an extra hit of over ₹3.45 lakh in the total interest payment. Similarly, if one’s loan of ₹ 50 lakh is for 20 years, then with the rate going from 8.50% to 9.25%, the monthly EMI will directly increase from ₹ 43,391 to ₹ 45,793, which will lead to an additional interest payment of more than ₹ 2,400 every month and about ₹ 5.76 lakh in the total loan tenure.
While one aspect of the increase in repo rate proves to be a shock for the loan takers, it is a relief news for the common citizens and senior citizens who save. As policy rates go up, banks also have to revise their deposit rates to infuse liquidity into the system. This simply means that in the coming time, banks will increase the interest rates on Fixed Deposit (FD) and Recurring Deposit (RD). Elderly people or investors who rely on bank FD to meet their regular expenses will start getting the benefit of better returns on their deposits and secure monthly income.
If the interest rate hike cycle begins in FY 2027, borrowers should take some practical financial steps in time to avoid worsening their family budget. The first step is to partially prepay the loan principal every financial year by withdrawing a part of your savings or annual bonus. As the principal amount decreases, the interest burden decreases rapidly. Another way is that if your bank’s interest rate is much higher than other competing banks, then talk to your current bank about loan resetting or consider the option of home loan balance transfer to a bank with a lower interest rate. Additionally, it would make financial sense to reserve an additional buffer of 10 to 15 percent in your budget for monthly EMIs in advance by cutting down on non-essential expenses.