Rising interest on loans: 5 money tips to lower your anxiety

There has been a sharp rise in household debt in the last two years as more and more individuals took loans to purchase houses, vehicles, consumer goods or fund expensive holidays taking advantage of a sharp decline in interest rates following the outbreak of the Covid19 pandemic in March 2020.

This is over and above what individuals owe to specialised non-bank lenders such as housing finance companies, vehicle financiers and gold loan companies among others. 

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The rise in household debt has been much faster than the growth in income and salaries during the post-pandemic period. Things were fine as long as interest rates were low. But there has been a reversal in the interest rate cycle in the last six months and banks have hiked the interest rate on various categories of personal loans by up to 200 basis points. One basis point is one-hundredth of a percent. Higher interest rate translates into bigger EMIs or longer loan tenure or both.

Besides, there has been a sharp rise in the cost of living in the last one-and-a-half years due to higher commodity, energy and food prices and a general rise in inflation. A combination of higher interest rates on loans and higher living expenses has started to strain the monthly budget of many households. 

Here is what you can do if you are facing financial strain due to a rise in EMIs on your loans:

1. Know your vulnerability to a rise in interest rates. You can do this by calculating your LSR or loan servicing ratio. The higher your LSR, the lower your financial vulnerability to the rise in the interest rate and vice versa. To compute LSR, first add-up all your income and cash inflows including imputed savings on house rent if you are living in the house you have bought on loan. The next step is to find the combined monthly outgo on all your outstanding loans. Now divide your monthly income in hand/cash inflow with the total LMI to get LSR. 

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However, you and your family need to sit down and have a frank discussion on your finances if your LSR is closer to 2X. And you are in the red zone if your LSR has declined to 1.5X or lower.

2. Calculate your net worth. Your personal or family’s net worth—the difference between the current value of assets and debt—is the crucial number that tells you where you stand financially. Calculate your assets by adding up the current estimated market value of all your possessions such as a house, any free-hold land, stocks and mutual fund units, the surrender value of life insurance policy, vehicles, bank balance and FDs and gold & silver in the possession of your family. 

Now subtract your total outstanding loan from the current value of your assets to get your net worth. If your net worth is significantly higher than all your outstanding loans and continues to grow, then you should not lose sleep over a 10-20 per cent rise in EMIs. But you need to think hard if your net worth is lower than the loan outstanding, just about covers it or is not growing at all.

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3. Explore the possibility of reducing interest on your existing loans. The interest rate on the loans determines the servicing cost or Equated Monthly Installment (EMIs). If the EMI has started to bite you then see if you can reduce your monthly outgo by transferring your loan to another bank or institution.

Alternatively, talk to the officer at your existing bank and request him to reduce interest on the loan by making a one-time conversion fee. Most home loan companies offer the option to reduce the spread over their base rate if you pay a lump sum fee. Another way to reduce EMI is to extend your loan term or the tenure of the loan.

4. Retire or pre-pay the high-cost credit card and personal loan: Consumption-related personal loans and unsecured credit such as credit card debt carry the highest interest rate and can become a financial minefield in an era of rising interest rates. If high debt and EMIs on them are keeping you worried then they should be tackled first. 

Also Read: Should you prepay your home loan?

If the loan amount is big you can even explore the possibility of selling some of your assets such as real estate or jewellery to retire these high-cost debts.

5. Refinance your high-cost debt by borrowing against assets: Loans against fixed assets such as a house, non-agricultural land and gold jewellery are far cheaper than unsecured personal loans and credit card debt. Banks also provide low-cost loans against financial assets such as shares & debentures, life insurance policies, mutual funds units and bank fixed deposits among others. 

Here the top-up loans against your existing home loan should be the first option followed by a loan against property, followed by a loan against LIC policies and gold loans.

Lastly, if most of your debt is secured and you have taken it to purchase an income-generating asset such as a house or commercial property, then you shouldn’t worry too much. A loan for an asset that can yield income is self-extinguishing if you manage to wait out long enough. You should worry about them only if the quality of assets is far worse than expected. In the worst case, you can always sell the asset and repay the loan.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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