The Reserve Bank of India (RBI) has issued a directive on August 18, requiring banks to provide individual home loan borrowers who are paying Equated Monthly Installments (EMIs) under the flexible interest dispensation with a range of options. The move aims to prevent borrowers from falling into negative amortization due to the increasing interest rates, a situation where EMIs are insufficient to cover the interest due.
The RBI’s directive mandates banks and home loan companies to implement these options by December 31, 2023. Negative amortization occurs when EMIs fail to cover the accrued interest, resulting in borrowers needing to extend the loan tenure or accept higher EMIs. The RBI aims to provide borrowers with alternatives to navigate this challenging scenario.
The central bank’s directive offers borrowers three choices: (1) opt for a fixed interest rate system, (2) increase the loan amount, or (3) extend the loan tenure. The RBI’s objective is to empower borrowers to make informed decisions that align with their financial circumstances.
However, the option to migrate to the fixed interest rate regime seems to pose a significant dilemma for borrowers. Banks and home loan companies currently offer fixed interest rates ranging from 14% to 17%, dependent on factors such as the borrower’s credit rating and tenure. This fixed rate is notably higher compared to the floating rate, which, until a couple of years ago, hovered around 6% before external factors like the COVID-19 pandemic and geopolitical tensions influenced an increase.
The RBI’s move has stirred discussions about the pros and cons of fixed versus floating interest rates. Many borrowers are wary of the fixed rate option due to the prevailing high rates, while the allure of potential future decreases in floating rates encourages borrowers to stick with their current arrangement. The decision-making process for borrowers will be influenced by factors like their age, financial stability, and risk appetite.
Critics have argued that the RBI’s decision to raise interest rates by 250 basis points in the past two years reflects an adherence to global trends without yielding the desired results. India’s unique economic challenges, particularly supply-side constraints contributing to inflation, have caused some to view the central bank’s policy decisions as misguided.
In light of the RBI’s recent directive, borrowers will need to evaluate their options carefully. While some may choose to stick with the familiar flexi rate regime in hopes of eventual interest rate decreases, others might explore changing loan tenures or accepting higher EMIs. The fixed rate option, given the current rates, remains a less attractive choice for many borrowers.