MUMBAI: Borrower loan eligibility could drop while banks and finance companies will be forced to hike the EMI (equated monthly instalments) for some home loans when interest rates rise under the RBI’s new rules. Banks will henceforth have to give borrowers the option of shifting to a fixed rate loan at the time of reset of interest rates.
Also, in future loan sanction letters will have to disclose the charges for switching a loan from a floating to a fixed rate at a future date. If rates rise sharply, lenders must ensure that the EMI continues to cover the monthly interest on the loan and that the loan outstanding does not increase from the previous month’s level after EMI is paid.
In its circular on reset of floating interest rates on EMI-based personal loans, RBI said that lenders must not calculate repayment capacity based on prevailing interest rates but must leave headroom to ensure that borrowers can repay even when interest rates rise.
In the past, interest rates have swung by up to six percentage points within a loan cycle. Lenders have not always reset the EMI as they would earn more interest by extending the EMI. The new norms require lenders to calculate repayment capacity at a higher than prevailing rate.
Currently, banks calculate the borrower’s ability to repay based on the prevailing interest rates. For instance, a borrower with 20 years to retire may be able to afford the Rs 74,557 EMI for a Rs 1 crore loan at an interest rate of 6.5%. However, this affordability would drop to Rs 72 lakh at an 11% interest rate.
Most banks currently do not offer fixed rate loans because their deposits are short-term. A senior banker said that if they were forced to offer a fixed rate, there would be a sufficient mark-up to take care of interest rate risks.
“Regulated entities are required to take into account the repayment capacity of borrowers to ensure that adequate headroom/ margin is available for elongation 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.
RBI governor Shaktikanta Das had last week said the central bank would reveiew EMI norms as there was concern over banks unduly elongating home loans after interest rates rose. He said banks will have to assess the appropriate tenure taking into account the payment capacity of the borrower and how long his payment capacity is lasting, going by age. It will vary from individual to individual. Also it is necessary to avoid unduly long elongation which sometimes may going forward camouflage the underlying stress in a particular loan. Therefore, the extension of tenure has to be for a reasonable period. We do not want to define it. It is a commercial decision of the banks,” said Das.
The new rules will be applicable from December 31, 2023, for new and existing borrowers. They will bring in more transparency as lenders must disclose the principal and interest recovered to date, EMI amount, number of EMIs left and annualized rate of interest / Annual Percentage Rate (APR) for the entire loan tenor.
Historically lenders would factor in the rise in income and the cyclical nature of interest rates when deciding borrower eligibility. However, there are instances now of pay scales failing to keep up with inflation in some industries. Also, in the West, banks are bracing themselves to live with `higher for longer’ interest rates.
With home loans being one of the biggest drivers of credit growth, most lenders now focus on this segment to grow their advances book. To expand the pie, finance companies have been pushing on the affordable segment, which has many new to-credit customers unfamiliar with the impact of rising rates.
“Apart from the equated monthly instalment loans, these instructions would also apply, mutatis mutandis, to all equated instalment-based loans of different periodicities, “RBI said. This indicates that lenders will have to tighten norms for loans against property and probably education loans which are the other two categories with long tenure.
