What should you do if your loan EMIs have increased? Increase in rates by RBI

The word EMI has become a very common term for most of us where the constant struggle is to meet the ends and ensure that there is no default in EMIs. during the covid period, most lenders offered moratoriums to their borrowers to protect themselves from bad debts and at the same time provide some relief to the borrowers. Gone are the days of that relief and now the current scenario requires the borrowers to pay increased EMIs. These increased EMIs have created a huge burden on the borrowers. Given below are a few pointers that can help borrowers in case of increased EMIs.

Why has the loan EMI increased?

Before going any further, let us first understand why the EMIs across all the loans have increased in recent times. We all know that the inflation in our country as well as across the world has gone to huge heights. One of the ways to tackle this rising inflation is by increasing interest rates. With this view, 

RBI has increased the repo rate by 40 basis points in May 2022 and later by 50 basis points in June 2022. The repo rate was increased from 4% to 4.9% in a span of 2 months.

The direct impact of this interest rate hike is seen in the loans offered by the banks and NBFCs as these institutions have also increased their interest rates in response to the RBI’s decision. This immediately translates to an increase in the EMI for the loans already borrowed. The increased loan will take a toll on the financial planning of the borrower and therefore they will need careful planning to overcome this added expense. 

What are the options available to borrowers facing increased EMIs?

As mentioned above, the EMIs on the loans will increase due to the interest rate hikes and most experts believe that in the coming months, the apex bank may consider increasing the repo rates further to battle the high inflation. In order to combat the high EMIS, there are several options that the borrowers can consider and lower their burden. Some of such options are given below. 

1. Opt for a balance transfer option

The increase in the repo rates affects all the financial institutions. However, banks have varied interest rates based on their cost of lending. The variation may not be too much but even a difference of 1% can be huge over the tenure of the loan and can help save a significant amount in loan EMIs. Therefore, borrowers can review the available loan options and opt for the balance transfer to reduce their loan burden. 

2. Use any excess funds for part payment or prepayment of the loan

Part-payment and prepayment option is available on most loan options offered by lenders. If such options are available then borrowers can opt for the same. They can use any windfall gain or any surplus funds available to them to make such payments. This will reduce their outstanding loan amount thereby reducing the EMIs.

3. Opt for extending the tenure of the loan

Another option that is often taken by borrowers is extending the tenure of the loan. Through this option, borrowers can maintain the same level of EMI but will have to pay for a longer tenure. This option is a costlier one as the total interest amount increases paid over the tenure of the loan increases. Hence, borrowers need to be cautious before choosing this option and have enough funds to meet the additional cost of borrowing.

4. Apply effective debt management

When the interest rates are increased by the central bank it affects all the loans. In such a case if a person has multiple loans (like home loan, credit card loans, personal loans, etc.), It is prudent to close those loans first that have a higher rate of interest. For example, in case of credit card loans and home loans, credit card loans have a much higher interest rate and a continuous default can also attract a penalty from the card issuer. Therefore, the borrower should clear the credit card loan first in such cases. Clearing a loan with higher rate of interest first will also effectively reduce the overall cost of borrowing for the borrower in the long run.

5. Invest strategically to meet the excess EMI outflow

The increase in EMI cost cannot be controlled by a borrower, however, investments are something that can easily be controlled and altered by a person to meet their financial needs. Therefore, another important response to increased EMIs can be an increase in the investment that provides higher returns to meet the additional cost of borrowing. For example, if the increased interest rate on a home loan is 7.5%, the borrower can invest in aggressive hybrid mutual funds, index funds, ETFs, blue-chip stocks that can provide returns in the range of 8% to 10% so the additional interest cost is covered against the returns earned from an investment. 

6. Evaluate the financial plan

Changes in the interest rates in the economy is also a good opportunity to re-evaluate the financial plans. A person can prioritise their financial goals to be in sync with their current financial outflow at the same time ensure financial security for themselves as well as their family members. Funds allocated towards goals that can be out to hold should be diverted towards the excess EMI outflow or should be postponed till the time sufficient funds are available to meet the same. 

7. Cut any investment with low returns from the portfolio

Another tip that can be a continuation or part of the need for strategic investment is to cut any investment that no longer provides decent returns. This includes any investment that has continuously underperformed or has been giving negative returns. The funds released from such investment can be used to prepay or part pay the loan to reduce the overall EMI cost.

8. Avoid any new loans

The decision of taking new loans at the time of higher interest cost should be after careful consideration of the EMI outflow and the means to meet the same. If the expense for which loan is needed can be postponed, then it is prudent to do so and wait for the interest rates to come down so the EMIs on the same can be affordable. 

What is a better option- pay increased EMI or increase the tenure of the loan?

When the EMI cost increases, borrowers essentially have two options, i e., either pay the increased EMI or to increase the tenure of the loan. In the first option, the EMI cost is increased on account of additional interest to be paid on the loan but the tenure is the same while in the second option, the EMI remains the same but has to be paid for additional months to meet the increased interest cost. 

Borrowers should ideally opt for the first option in case they can afford to pay the additional EMI as the overall interest cost on the loan is still lower than that in case of increased tenure. An overall financial plan needs to be considered before taking such a decision as it has long term repercussions in either case. There is no correct answer to choose between the two. The final decision will depend on the borrower’s immediate ability to pay the increased EMI or to pay a higher total interest on the loan for longer tenure and meet other immediate financial obligations. 

Conclusion

An increase in EMIs is a burden that no person wishes to bear. It shakes the entire financial planning which needs to be revised to accommodate the increased cost of borrowing. Therefore, it is essential to always have an emergency fund and sound financial plan to safeguard against any such unforeseen financial emergency or additional financial burden without hampering a person and their family’s survival. 

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