Inflation is like a storm which leaves no one unaffected, and just like the rest of India’s markets, inflation impacts Home Loan rates as well. It is important to know how your interest rates are affected and to truly understand this complex idea, you must start from the beginning.

We all know inflation is a phenomenon that simply strips away the value of currency by increasing the prices of goods and services. The more prices rise, the higher the impact of inflation on Home Loan rates. This causes bank funds to rise, which in turn causes loan rates and EMIs to increase as well—quite a vicious cycle.

An year with high inflation rates isn’t the best time to buy a home, because once you’ve committed to the purchase, there is no easy way to get out.

What Causes Inflation?

There are three kinds of inflation, depending on how it is caused.

  • Cost push inflation is caused when the price of raw materials or the costs put in to manufacturing products rise. This in turn increases the selling price of the final product.
  • Demand-pull inflation happens when the demand for a particular product rises, but the supply stays the same. This simply makes the product a rarer commodity, therefore resulting in it being more expensive.
  • Sometimes, the government will produce more currency to manage expenditures and pay off debts. This will lead to a sudden increase in the supply of money but not an increase in the number of goods and services. This leads to an imbalance; an increased amount of money with the country leads to a decreased value of money.

If you are wondering how inflation impacts Home Loan rates, look back at the value of simple products. Years ago, the simplest products like rice or vegetables were priced around INR 2 per unit. Overtime, the price has drastically increased and this has happened because inflation has reduced the purchasing power of money. What you might spend INR 10 on today will cost a lot more 10 years down the line.

Also Read: Charges Other Than Interest Associated With Home Loans

How Banks Deal with Inflation

This is how inflation affects interest rates. The rising price rule applies to banks and lenders; they know that inflation affects the value of money over time, making inflation effects on your Home Loan inevitable. For example, if your loan payment every month is about INR 1000, and you continue to pay that amount for 5 years, its value will not be the same as when you first began paying your instalments. This simply pushes banks to increase interest rates that match the new value of money and also gives them a better real return. This can be a con while paying off your Home Loan. The real return is the value of the investment after deducting the rate of inflation.

In order to contain the rising inflation rates, the Reserve Bank of India (RBI) enforces measures such as hiking the Cash Reserve Ratio (CRR), the repo and reverse repo rates, and reducing the rate of interest on CRRs.

CRRs’ Influence in Interest Hikes

The Cash Reserve Ratio is the amount that commercial banks must maintain with the RBI. It’s what the RBI uses to keep an eye upon the supply of money and interest rates. When inflation increases, CRRs increase, thereby drawing out excess money from the banking supply to contain the price rise. This in turn reduces the kitty in commercial banks, thereby reducing the amount of money that can be given out on loans and increasing interest rates, therefore increasing the effect of inflation on housing prices.

The Effects of Increased Repo and Reverse Repo Rates

These rates might not make sense to a lay person, but they have a direct impact on your Home Loan. To understand these terms, here is a brief explanation:

The Repo rate is the estimate at which the RBI lends out money to public and private sector banks. The Reverse Repo rate is the opposite; it’s the rate at which the RBI borrows money from other banks.

A hike in the repo and reverse repo rates increases the cost of funds for banks. To pay off these extra funds, banks generally pass on the cost to their borrower, thus increasing interest rates.

Another way is to pay off your Home Loan when you have surplus funds and calculate other charges associated with your loan. Even if it isn’t the complete amount, you know you can clear your debts quicker. Remember, the longer you wait to pay off your loan, the more you will end up paying. You could try a loan provider like Bajaj Finserv if you want a convenient and affordable Home Loan. They offer the lowest interest rates and you can apply for the loan online.

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