Is the borrower in a debt
trap?
BE CAUTIOUS: Think twice before seeking a housing loan
There has been a dramatic change in the home loan scene in recent times.
For the Indian banks, granting a loan to purchase or build a
house was taboo in the 70s and even 80s. Subsequently, when the home credit got
the `priority' tag, banks vied with each other in wooing prospective borrowers
by offering liberal terms, even for purchase of land, redemption of prior debt,
hundred per cent finance etc.
The low interest rate regime and tax sops saw even the
average salary earner going into his own dream house, nay, houses, by obtaining
multiple borrowings! When the interest rates fell, many opted for the floating
rate expecting a further fall.
The home loan portfolio of banks accordingly, grew to an
unprecedented 33 per cent by 2006, thanks to the multitude of real estate
developers and FDI investors. However, new issues like the rising interest rate
and EMI cropped up like a bolt from the blue.
Interest
rates
The interest rate in India is controlled by the Reserve Bank.
For many years, the RBI has been facing flak in this area, rightly or wrongly.
As we can comprehend, it is not a pleasure for the RBI to use this tool for
increasing or decreasing the money in circulation which has a strong bearing on
the price levels.
When the interest rates rise, no borrower is happy. The
spiralling prices and the inflationary pressures on the economy then compels all
central banks to use the interest rate tool often in controlling credit.
The RBI has, thus, raised the repo rate 4 or 5 times in the
last couple of years; the latest being the revision to 7.75 per cent in an
impromptu announcement on March 30, a month ahead of the annual credit policy
announcement.
With inflation remaining above six per cent since January
2007, armed with the recent amendment to the Banking Regulation Act, giving RBI
the powers to dabble with the Cash Reserve and Statutory Liquidity Ratios, a
further rise of 0.25 per cent in CRR, the third successive rise in the recent
past, has also been announced. Each change in repo interest rate effected by the
Reserve Bank will have a snowballing effect on the general rates, in as much as
the banking and financial institutions will revise their interest on both
deposits and loans. Most affected by this move will be the retail sector that
includes personal loans, auto loans and housing loans. Housing loans being long
duration loans, the impact will be heavier.
Debt trap
Each upward revision will make the EMI (Equated Monthly
Instalment) higher, whether the tenure of the loan remains static or not. For
example, a loan of Rs.10 lakhs taken for120 months at a floating rate of eight
per cent will have an EMI of Rs.15,000 approx. When the interest rate goes up to
nine per cent, the EMI will also go up by about Rs.830.
If the EMI remains unchanged, the tenure of the loan will be
going up by another 6 months.
With every rise of one per cent in interest, the tenure will
go up further by six months.
Here lies the perpetual debt trap!
The debt trap will be severe where compounding of interest
takes place, from month to month or quarter to quarter as is the practice in the
lender bank/ financial institution for application of interest.
The increase in EMI and the periodical increase in interest
rate will eat away a major portion of the repayments made, and the outstanding
loan will not be showing a marked reduction.
Many bankers vouch that it is their practice to increase the
EMI or tenure or both, depending on the size of the loan and the borrower's
repaying capacity, to prevent the account from turning non-performing (NPA)
The cost of the property will escalate as inflation worsens,
should higher repayment levels be met.
In order to service the debt, the borrower will have to
tighten the belt by sacrificing many other needs. The maintenance cost of the
property, another unavoidable burden, also comes in.
A way out from the debt trap will be to borrow less or defer
buying a house till the inflation scenario changes and the interest rate
increase is reversed by the balancing of demand and supply.
Don't be overwhelmed by the interest rate rise, but wait for
a better day.
Another possible scenario that will help the borrower will be
stern action by the Central and State Governments for controlling the developing
and buying spree.
K. SUKUMARAN
Courtesy: Property Plus, The Hindu
http://www.hindu.com/pp/2007/04/07/stories/2007040700260100.htm
