How does a change in interest rate affect a home loan?

A change in interest rate can affect either your EMI, your loan tenure, or both. When rates rise, your EMI may increase or your lender may extend the repayment period. When rates fall, your EMI may reduce or, if you keep paying the same EMI, your loan may be repaid faster.

Can a 1% increase in home loan interest rate increase the loan tenure by 5 years?

Yes. For a ₹1 crore home loan with a 20-year tenure, an increase in interest rate from 8% to 9% can extend the loan tenure by more than five years if the EMI remains around ₹84,000 per month.

How much can a 1% increase in interest rate increase my home loan EMI?

For a ₹1 crore, 20-year home loan, an increase in interest rate from 8% to 9% can increase the EMI by more than ₹6,000 per month.

What happens if home loan interest rates rise but I keep my EMI unchanged?

If interest rates rise and you keep your EMI unchanged, a larger portion of each EMI goes towards interest. As a result, the principal is repaid more slowly and the bank may extend your loan tenure significantly.

What happens to my home loan when interest rates fall?

When interest rates fall, your EMI may decrease. If you continue paying the same EMI instead of reducing it, more of each payment goes towards principal, which can shorten the loan tenure and reduce the total interest paid.

How much can a 1% fall in interest rate reduce my home loan tenure?

For a ₹1 crore, 20-year home loan, a fall in interest rate from 8% to 7% could reduce the loan tenure by about three years if you continue paying the original EMI. The loan could therefore be repaid in around 17 years instead of 20 years.

How is a repo-linked home loan interest rate calculated?

A repo-linked home loan rate is generally calculated as: Home loan interest rate = RBI repo rate + bank spread For example, if the RBI repo rate is 5% and the bank spread is 3%, the home loan interest rate would be 8%.

Why does the RBI repo rate affect my home loan?

Many floating-rate home loans are linked to an external benchmark such as the RBI repo rate. When the repo rate changes, the interest rate on a repo-linked home loan may also change, affecting your EMI or repayment tenure.

Should I take the maximum home loan EMI I can afford today?

No. You should keep a buffer in your monthly budget because interest rates can rise during the loan tenure. If you borrow at your maximum affordability, even a relatively small rate increase could put pressure on your household finances.

How should I stress test my home loan before borrowing?

Before taking a home loan, check how your finances would be affected if the interest rate increased by 0.5%, 1%, or even 2%. Compare the resulting EMI, loan tenure and impact on your monthly budget before deciding how much you can safely borrow.

Impact of Interest Rate Movements on Your Home Loan

1% increase in interest rate can increase your loan tenure by 5 years!

First, let's take a look at key takeaways from the article

Key Takeaways

- A 1% rate increase could extend a 20-year home loan by more than five years.

- Keeping your EMI unchanged when rates rise can significantly increase your repayment period and total interest.

- Falling rates can help you repay the loan faster—provided you continue paying the same EMI.

- Never borrow at your maximum affordability. Keep an EMI buffer and stress test higher interest rates.

Now that we've looked at the important takeaways, let's dive deep into the article

1% increase in interest rate can increase your loan tenure by 5 years!

Most home loans in India are floating-rate loans. This means the interest rate can change from time to time during the loan tenure.

Over the last few decades, home loan interest rates in India have broadly moved between around 7% and 16%. In recent years, however, home loan rates have generally remained below 10%.

Today, most floating-rate home loans are linked to an external benchmark, such as the RBI’s repo rate. A repo-linked home loan rate is usually calculated as:

Home loan rate = RBI repo rate + spread

The spread is the additional rate charged by the bank over the repo rate. For example, if your loan has a spread of 3% and the RBI repo rate is 5%, your home loan interest rate will be:

5% + 3% = 8%

The spread may vary from bank to bank and may also depend on your creditworthiness. However, once the loan is sanctioned, the spread generally remains unchanged during the loan tenure, unless the loan terms are revised.

The RBI reviews the repo rate periodically, usually once every two months. When the repo rate changes, your home loan rate may also change. For example, if the RBI reduces the repo rate by 0.25%, your home loan rate may also reduce by 0.25%, from 8% to 7.75%. Similarly, if the RBI increases the repo rate, your home loan rate may also rise.

This is why interest rate movements matter in a floating-rate home loan.

What Happens When Rates Fall or Rise

When interest rates fall, your EMI may reduce. Alternatively, if you keep your EMI unchanged, a larger portion of each EMI goes towards principal repayment. This helps you repay the loan faster and reduces the overall tenure.

The opposite happens when interest rates rise. Your EMI may increase. If you do not increase your EMI, the bank may extend your loan tenure instead.

Let us take an example.

Assume you have taken a home loan of ₹1 crore for 20 years at an interest rate of 8%. Your EMI would be about ₹84,000 per month.

Now assume the interest rate increases by 1%, from 8% to 9%. In this case, your EMI would rise by more than ₹6,000 per month. If you do not want to increase your EMI and continue paying around ₹84,000 per month, your loan tenure could increase by more than 5 years. In other words, instead of repaying the loan in 20 years, you may need more than 25 years to repay it.

On the other hand, if the interest rate falls by 1%, from 8% to 7%, your EMI would reduce by about ₹6,000 per month. If you continue paying the same EMI as before, your loan tenure may reduce by about 3 years. That means you could repay the loan in around 17 years instead of 20 years.

Even a 1% change in interest rate can therefore have a significant impact on either your monthly EMI or your repayment period.

When Extending Tenure Is Not Enough

There is another important point to remember. In some cases, when interest rates rise sharply, simply extending the loan tenure may not be enough. Your EMI may have to increase because, beyond a point, the existing EMI may not even be sufficient to repay the loan within a reasonable period.

This is why you should not take a home loan assuming the maximum EMI you can afford today. Keep a buffer in your monthly budget. Interest rates can rise, and when they do, you may be forced to allocate more money towards loan repayment.

Stress Test Before You Borrow

Before taking a home loan, stress test different interest rate scenarios. Check what happens if your interest rate rises by 0.5%, 1%, or even 2%. See how it affects your EMI, loan tenure, and monthly budget.

You can use our calculator to understand how a change in interest rate may affect your EMI or loan tenure.