After adopting the Reserve Bank of India’s new lending restrictions, borrowers’ eligibility for loans may reduce, compelling banks and finance companies to increase the Equated Monthly Installments (EMIs) for certain house loans due to the impact of rising interest rates. As a result, during the interest rate reset phase, banks must now give borrowers the option to switch to fixed-rate loans.
Under the new regulations, loan sanction letters must also mention the cost of transitioning from a floating to a fixed interest rate in the future. To prevent any rise in the outstanding loan balance from the previous month after paying the EMI, lenders must ensure that, even during significant rate hikes, the EMIs will consistently cover the monthly interest payments.
Lenders should not only assess repayment capacity based on the current interest rates, according to the RBI’s circular on resetting floating interest rates for EMI-based personal loans. Instead, they should take into account a cushion to ensure borrowers can meet their payment obligations even if interest rates rise.
In the past, interest rates have changed by up to six percentage points in a single loan cycle, which indicates that the interest burden has increased significantly and that the loan term has often increased by years. Since extending the EMI length would result in larger interest earnings, lenders have occasionally hesitated to make EMI adjustments.
Currently, banks use the current interest rates to assess borrowers’ ability to repay. For instance, a person with 20 years left till retirement may be able to pay an EMI of Rs. 74,557 for a Rs. 1 crore loan at a 6.5% interest rate. However, their affordability might drop to Rs 72 lakh at an interest rate of 11%.
Due to the nature of short-term deposits, the majority of banks do not now offer fixed-rate loans. According to a senior banker, banks would include a substantial markup to reduce interest rate risks if obliged to offer fixed rates.
“Regulated entities are required to take into account the repayment capacity of borrowers to ensure that adequate headroom/margin is available for alongation of tenor and /or increase in EMI, in the scenario of a possible increase in the external benchmark rate during the tenor of the loan,” the RBI said.
Shaktikanta Das, the governor of the RBI, stated last week that the central bank would review the EMI rules to address concerns over banks unnecessarily prolonging house loan terms in order to increase interest rates. According to him, banks should consider age-related aspects when determining the right tenures based on borrower payment capacity.
A senior private bank executive claimed that they had observed numerous instances of loan terms that were longer than average life expectancy.
Both new and current borrowers are subject to the new regulations, which take effect on December 31, 2023. Requiring the disclosure of principal and interest recovered to date, the number of EMIs still pending, the amount of each EMI, and the annualized rate of interest (APR) for the entire loan term contributes to increased transparency.
When determining a borrower’s eligibility, lenders have historically taken into account rising income and the cyclical nature of interest rates. However, in several industries, wages have not kept up with price increases. In addition, Western banks are preparing for extended periods of high interest rates.
Most lenders concentrate on this industry to increase their lending portfolios since house loans play a vital role in credit expansion. Finance businesses target the cheap housing market to appeal to a wider demographic, which includes many people who are new to credit and are not aware with the effects of rising rates.
The RBI made it clear that, in addition to equated monthly Installment loans, these guidelines will also apply to all equated installment-based loans with varied frequency levels. As a result, lenders must tighten guidelines for loans against property and possibly student loans, both of which fall under the category of long-term loans.
Source: https://m.economictimes.com/industry/banking/finance/banking/rbis-new-rules-may-increase-your-emis-make-it-difficult-to-get-home-loans-for-some/articleshow/102848588.cms