What Goes Into Calculating Home Loan Interests?

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  • By Admin
  • Jan 04, 2019

Availing a home loan has become much easier at present with the numerous lenders in the market offering competitive interest rates. Most people aim to find the lowest interest rates possible, so knowing how interest rates are calculated and what factors can affect them can really help.

What Are Home Loan Interest Rates?

The home loan interest rate is basically a percentage fee that is applicable on the amount of money borrowed. This is a percentage of the total principal amount that is to be paid by the borrower.

While it is a fact that the home loan interest rate may vary from lender to lender, the base rate of interest also fluctuates from time to time, based on a number of factors.

Factors That Affect Home Loan Interest Rates

Mostly, the interest rate applicable on a home loan varies depending on the supply and demand of money in the economy. However, the RBI also tends to influence the interest rates in different ways:

          1. Changes In The Monetary Policy

In India, the financial strategy of the Reserve Bank of India is always aimed at promoting economic growth and stability. For this purpose, the RBI exercises control over different monetary policies, like liquidity, money supply, benchmark interest rates (like repo and reverse repo rates), statutory liquidity ratio (SLR), cash reserve ratio (CRR), etc. So, if the Reserve Bank loosens the monetary policy (adds to the cash supply or increases the liquidity in the country’s economy), the prevalent interest rates on home loans will reduce, and vice versa.

For example, the main way in which the RBI reduces or increases the liquidity in the economy is via repo rates (this is the rate at which a bank may receive a loan from the RBI). So, a change in the repo rate will affect a change in the home loan interest rate.

          2. Growth Of The Economy

It goes without saying that the economic standing of a country will have a direct impact on the home loan interest rates. If a country has a steadily growing economy, it implies that the population enjoys stable incomes as well as a higher purchasing power. This in turn would increase the population’s demands for funds, and the home loan interest rate will increase with respect to the increase in demand. This is a basic demand and supply notion.

          3. The Rate Of Inflation

Inflation refers to the rise in the costs of goods and services that is seen in an economy over time. With the rise in inflation, a reduction in the purchasing power of a currency unit decreases. So, home loan interests tend to increase with an increase in inflation.

          4. Uncertainty In The Economy

In an unpredictable economic growth, lenders tend to ask for higher interest as a security against the higher associated risks of default.

          5. International Market Condition

The condition of the global economy also influences the flow of foreign investments into a country’s markets. Thus, they also influence the value of currency as well as the lending in the country.

          6. Fiscal Deficit

If a rising budgetary deficit implies that a government might have to borrow finances from the market, it indirectly escalates the borrowing rates as well.

It is an undeniable fact that the fluctuations that are seen in the interest rates of home loans also impact the borrowing behaviour, as people may avoid opting for home loans when the interest rates are too high. A thorough research in the trends of interest rate fluctuations can really help one in deciding the best time to avail a home loan. But that too is an unpredictable premise. That is the reason why many people tend to opt for floating interest rate home loans, where the interest rates constantly change, depending on the market conditions. In such a case, while the interest rate may be lower for certain periods of time, it will also be slightly higher when the market conditions are not the most favourable.


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