Home loan rates get cheaper, but here's a trick borrowers need to know

The State Bank of India(SBI) and the Housing Development Finance Corporation(HDFC) have both cut their home loan rates by 25 basis points (one basis point is one hundredth of a percentage) to 9.90 percent. Further, SBI will charge an interest rate of 9.85 percent to women borrowers.[caption id=“attachment_1297567” align=“alignleft” width=“768”]  Cheaper homes? AFP[/caption] The real estate industry as expected has gone gaga over these interest rate cuts. Getamber Anand, the president of Confederation of Real Estate Developers Association of India (CREDAI), told The Economic Times: “Single-digit home loan rates coupled with the festive season will surely bring fence-sitters to the market and boost housing demand from October this year.” Data from the National Housing Bank shows that the average home loan size in India in 2013-2014 stood at Rs 18-19 lakh. Let’s round it off to Rs 20 lakh, given that we are now in 2015-2016. At 9.90 percent, the equated monthly installment (EMI) on a twenty year Rs 20 lakh loan works out to Rs 19,168.11. This is Rs 331.51 lower than the EMI at 10.15 percent (the rate of interest before the interest rate was cut) which was at Rs 19,499.62. So, the question, as I have asked in the past, is whether an individual will go ahead and buy a home just because the EMI has come down by a little over Rs 300? The answer is obviously no. Readers living in big cities might complain that Rs 20 lakh is too low a number. So let’s consider a larger home loan amount of Rs 50 lakh. At 9.90 percent, the EMI on a twenty year loan works out to Rs 47,920.28. This is Rs 828.76 lower than the EMI on a 10.15 percent loan, which was at Rs 48,749.04. An individual who can afford a loan of Rs 50 lakh, would be making anywhere around Rs 18-20 lakh per year, and would surely not be bothered by an amount slightly greater than Rs 800. So, all the optimism portrayed by CREDAI doesn’t make any sense. The basic problem with real estate is high prices. And no amount of interest rate cuts is going to sort that out. The EMIs now are simply way too high for most people looking to buy a home to live in. The real estate industry needs to come around to this basic fact. Further, sections of the media have given a positive spin to this rate cut. This is how the spin works. The EMI on a Rs 20 lakh, 10.15 percent twenty-year-loan, as we have seen above, works out to Rs 19,499.62. What happens if this EMI is used to repay a Rs 20 lakh home loan at 9.90 percent? The tenure of the loan comes down to around 228 months or around 19 years. The mathematics in case of the Rs 50 lakh also work out exactly in the same way. This basically means that a borrower has to pay EMIs for only 19 years against the earlier 20 years. In case of a 15 year loan, the difference comes to six months i.e., a 15 year loan now has a tenure of 14.5 years, which means six EMIs less. Suddenly the whole scenario starts to look better. But there is a very basic mistake that is being made in this calculation. The assumption being made is that interest rates will remain fixed over a twenty year period. But the very fact that the home loan being taken on is a floating interest rate home loans means it is not fixed. And hence assuming that interest rates will be fixed for 20 years and making a calculation is rather stupid. As far as predicting interest rates is concerned, it remains a very tricky business. Even most economists and experts can’t predict interest rates over the short term. Hence, predicting them over a 20 year period remains next to impossible. (Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)