4 Effective Strategies To Reduce Home Loan Debt

Though rate hikes have been paused since February 2023, the rate elevation has made home loans much costlier for borrowers, making it increasingly challenging for them to manage their debt burden

In India, over 90 per cent of home loans are on a floating rate basis and tied to a benchmark rate that determines the final rate.

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Having a home of your own is an aspiration cherished by many Indians. But, it is an expensive one to fulfil. Most people turn to home loans to finance their dream of owning a house. A home loan, however, is a long-term financial commitment, and depending on how you manage it, can either help you realise your dream, or harm your financial health.

Between May 2022 and February 2023, the Reserve Bank of India (RBI) raised the repo rate by 250 basis points, taking it from 4.00 per cent to 6.50 per cent. Though rate hikes have been paused since February 2023, the rate elevation has made home loans much costlier for borrowers, making it increasingly challenging for them to manage their debt burden.

What is the repo rate?

The interest rate at which the RBI lends short-term funds to commercial banks is known as the repo rate or repurchase rate. The repo rate is essential to the monetary policy in containing inflation and managing the economy's liquidity. When the repo rate rises, borrowing from the central bank becomes costlier for commercial banks which then pass these costs on to the customers by raising the retail lending rates, including for home loans. When the repo rate falls, borrowing costs also drop, which can promote spending and investing.

Speaking of home loans, in light of the repo rate hikes, and subsequent rise in home loan rates, it is crucial for borrowers to reduce their debt burden by exploring strategies to reduce interest and expedite repayment. Let’s look at some effective strategies borrowers can explore to manage and reduce their home loan debt.

Check Your Benchmark

In India, over 90 per cent of home loans are on a floating rate basis and tied to a benchmark rate that determines the final rate. Since October 2019, the repo rate, currently at 6.50 per cent, has been the benchmark for home loans. However, loans sanctioned between April 2016 and October 2019 were benchmarked to the Marginal Cost of Funds based Lending (MCLR), and to the Base Rate before that.

Now, older benchmarks tend to be stickier during high inflation periods and don’t fully reflect RBI’s rate cuts. MCLR-linked loans usually have a reset period of six months to one year, which can vary from bank to bank. So, if the bank reduces its MCLR, and your MCLR-linked loan has a quarterly reset period, your borrowing rate will reduce only after a quarter. As a result, you would continue paying the higher interest until the reset becomes effective on your loan.

However, in the case of repo-linked loans, the reset can happen soon after the RBI announces a change in the repo rate. This is especially beneficial in case of a drop in the repo rate, bringing down the EMI and interest payments for borrowers within a significantly shorter period.

Switch to a lower spread

The spread on repo-linked loans is a crucial factor, especially home loans. It is determined based on your credit score, income source, and the amount of loan you have requested. Also, the spread remains constant for the tenure of the loan. Home loan spreads in 2024 have gone down significantly compared to early 2020 when they ranged from 275 to 360 basis points above the repo rate. Currently, the lowest interest rates are between 8.20 per cent and 8.50 per cent, resulting in spreads as narrow as 170 to 200 basis points. When applying for a new loan, aim for a lower spread to benefit from future rate reductions. If you have an existing loan, consider refinancing to benefit from a lower spread.

Refinance to switch to a lower rate

If you are on a high-interest loan, explore switching to a lower rate. Explore refinancing to a lower rate with your existing lender as this option would involve a smaller processing fee and less paperwork. However, if that is not an option, consider refinancing with a different lender. This option would require more paperwork and costs, such as a processing fee, legal fee, and other charges. Before refinancing, do the maths and find out if this option lowers your interest outgo and is thus, financially beneficial.

Prepay to reduce your debt burden

Another effective option to reduce your debt burden is making prepayments on your loan. If you have the financial bandwidth, prepay 5 per cent of your outstanding loan balance annually. Alternatively, if you have surplus funds following a salary hike or bonus, use it to increase your EMI payment or make an additional EMI payment at the start of the year to shorten your loan tenure. However, if your interest rate is bordering on untenable, evaluate your finances and see if you can repay your entire loan. 

The rate hikes in the past have certainly affected borrowers’ finances, driving them to seek ways to reduce their ballooning debt burden. Under such circumstances, simply making scheduled EMI payments is no longer sufficient. For borrowers, rate fluctuations are an inevitable part of the borrowing process. What is essential, however, is that borrowers remain financially prepared to face the changes brought on by such fluctuations and continue on their journey to become debt free.

The writer is Manager, Communications at BankBazaar.com. This article has been published as part of a special arrangement with BankBazaar.