Monday, April 18, 2011

Effect of inflation in home loan

Inflation, as the economists say, is a necessary evil, is now haunting the economy and the economists with their policy makers. As a measure RBI is continuously slapping the interest rates on CRR (Cash Reserve Ratio) for controlling the liquidity in the market.

The CRR is the portion of deposits (net demand and time liabilities or NDTL) that is to be maintained by commercial banks with the RBI. The CRR is a tool used by the RBI to control money supply and interest rates.

A hike in the CRR draws out excess money from the banking system and check the rise in prices. This puts further upward pressures on interest rates. In addition, to further supplement the move, the RBI cuts the rate of interest payable on eligible cash balances maintained with it by banks.

Thus reducing the amount of resources available for lending with banks and lead to a rise in interest rates. Banks’ interest income will be negatively impacted by a hike in the CRR and reduction in interest rate.

The interest rates on various loans, including housing loans increase. Few years ago, gradual reduction in the CRR in successive credit policies had been one of the major contributors for the sustained reduction in interest rates on housing loans.

Simultaneously, the measures taken to control inflation also lead to increase in interest rates because of the increase in cost of funds or shortage of funds.

For example if a borrower pays an EMI of Rs. 20,000 towards his/her home loan, with increasing interest rates this may go upto Rs. 30, 000 per month which may pinch his monthly budget as his earnings may not increase simultaneously.

Simply speaking, when interest rate increases, you need to pay a higher amount as interest for the amount that you borrow.

This means one of the two things:
  • Your EMI amount increases to accommodate the increased interest payment, so that the tenure of your housing loan stays the same, or
  • The EMI remains the same and the tenure of the home loan increases, so that you can pay the increased interest through more EMI payments.


1 comment:

  1. I think it is true that inflation affect home loans and our economy. over here you have described all effects so thanks for this information because i was not aware about it.
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