Managing home loan EMI as interest rates go up

When interest rates go up, the interest burden of a home loan borrower would go up, and this needs to be compensated either by way of an increase in the tenure of the loan or an increase in the EMI.

Published: 09th May 2022 09:27 AM  |   Last Updated: 09th May 2022 08:58 PM   |  A+A-

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Express News Service

NEW DELHI:  Banks and housing finance companies have started increasing lending rates after the Reserve Bank of India (RBI) raised the repo rate - the rate at which banks borrow from RBI to cover their short-term fund shortages - by 40 basis points.

As a result, existing home loan borrowers, who opt for floating rate loans, might see the cost of their loans going up by 30-40 basis points, if not already. And if you are not yet aware of the revision of your home loan interest rate, it is likely your lender might have already increased the tenure of your loan, without you even knowing about it.

When interest rates go up, the interest burden of a home loan borrower would go up, and this needs to be compensated either by way of an increase in the tenure of the loan or an increase in the EMI.

If not chosen otherwise, the bank will increase the tenure of the loan instead of increasing your Equated Monthly Instalment (EMI), purely because changing the tenure is less of a hassle for bank as well as for the borrower than changing the EMI.

Increase in EMI vs in tenure
The dilemma that a borrower might now face is whether to let the tenure go up or the EMI.

The short and crisp answer to this is if you can afford, you should increase the EMI.

If your budget allows you then you can let the EMI go up so that the loan closes on the original schedule, otherwise it is fine to let the tenure go up, says Harsh Roongta, a fee-only Sebi registered Investment adviser.

However, the situation for home borrowers is not as simple as that given the fact that the latest increase in rates is probably just the beginning of many such hikes in future.

Dr Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, sees another round of rate hikes in June and August.

He says: “During the pandemic, RBI had reduced the policy repo rate by 115 bps in 2-instances (first 75 bps in March 2020 and thereafter 40 bps in May 2020) and it has been kept unchanged since then. With the current hike of 40 bps in repo rate to 4.40%, it seems the rate cycle has made a U-turn and RBI will continue to increase the rates and may reach the pre-pandemic level of 5.15% by end March 2023.”

Given this situation, home loan borrowers might have to think of either increasing the EMI or even making pre-payments to ensure that their home loan tenures do not go up too much.

Adhil Shetty, CEO of fintech company BankBazaar, says: "If you are unable to opt for a higher EMI, then you should make plans for regular prepayments. This is only the first hike and the global situation indicates that we may see an increase of 200 basis points in the interest rates over the next year or so.”

He, therefore, advises home loan borrowers against retaining current EMI without making prepayments as it could end up extending the tenure by a decade or more and doubling the cost of loan.

Doing the math

If you have an outstanding loan of Rs 50 Lakh loan at 7% with 10 years of tenure remaining, and the interest goes up by 40 bsp then you would need to pay around Rs 1,000 over your current EMI to ensure that the loan is closed on schedule (assuming the interest remains 7.4% for the rest of the tenure).

But if you don’t increase the EMI and let the tenure go up, you will have to pay for four additional months to close the loan.

If the loan rates are to increase to 8.5% in the next 12 months, then the tenure of the loan may go up by 12-14 months given the EMI is kept the same.

Making a prepayment is a good option to ensure your loan tenure does not increase for a very long time even if you keep paying the same EMI. Prepayment also ensures you pay less in interest for the loan.


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