Author: P.V. Subramanyam
So you quickly repaid a big part of your home loan because the interest rates went up did you? Welcome to the world of fluctuating interest rates!
Interest rates play an important role in your personal finances. The RBI tries to raise or lower key interest rates that trickle down and affects everything - from your housing EMI to the interest rates on your Savings Bank account. As rates begin to fall, what should you do?
Accept that Experts also only guess!
First of all it is necessary to understand that interest rates are a function of inflation, interest rates in other countries, money supply, government spending, government policy, demand and supply of money - from businesses and households, etc.
Even for experts being able to predict the US meltdown, the slowing down of growth in Asia, Brazil, etc. is not really easy. So generally they take a 2-3 month view - which is not useful when you are planning investments for the next few decades!
Planning for interest rate changes requires that you understand why RBI makes these decisions in the first place. In a democracy (in an election year that too!) governments are particularly sensitive to inflation. So the RBI is pressurized to reduce inflation - by sucking our liquidity in the market. Interest rates increase in an effort to make borrowing money less-attractive and slow a rapidly growing economy.
Exactly the reverse is done to make the economy go faster! Lowering the rate will make money flow more freely and hopefully stimulate economic growth.
Not always a blessing!
When interest rates go down, there is a sense of happiness amongst the consumers. Please remember you are a producer too! Decreasing interest rates is normally in response to a slowing economy. As we have seen the last few months have not been kind to anybody’s portfolio. All asset classes have done badly - we are only measuring how badly. If somebody told you cash is king, well it is because the others are paupers! Remember somewhere in your family your father, father-in-law, mother etc. are worried about lower bank interest rates.
Your strategy does not change!
Will you buy a bigger car because petrol prices have come down by Rs 5 a litre? Exactly so for your interest rates coming down. If you have a lot of debt, tackle the highest interest rate loans first. It still makes sense to cut down on loans. Especially if you realize that last years’ bonus figure is now in the history books. A rate change by RBI does not automatically reduce your interest rates.
Call your bank and ensure that your housing loan, credit cards, personal loans, etc. are all charged at a lower rate. A consumer is no longer the king unless he/she is well informed! Also realize ''we will get back to you'', ''we are examining your requests'' are all nice answers which actually does not reduce your debt! Try refinancing your loans if you must. Act tough - a few ''reputed'' organizations need more than a nudge to change!
For those who are looking to buy an asset (on borrowed money), or those on a floating rate already, decreasing rates is certainly a good thing. While housing EMI rates aren't directly linked to RBI's rate cuts, the signaling surely helps. Of course, do not get carried away and buy a house much bigger than what you actually need. Even those of you who have kept your savings in floating rate funds are now getting a higher return on your monies. If you already own a home and purchased it when the rates were a bit higher, this could be an opportunity to refinance. Even being able to reduce your borrowings by One point of interest can make a lot of difference, in the total price that your asset!
What about your Savings?
Clearly, low interest rates are great for borrowing money, but when it comes to trying to earn money on your savings, it isn't to your advantage. However, if you have invested in Hdfc Prudence or Templeton India Pension Plan, the debt portion would have appreciated in the last couple of weeks - a falling interest rate regime is benign for older portfolios. However, it will not happen continuously unless the interest rates keep falling. If your bank fixed deposit rates are dropping you should quickly tie-up for 18-36 months. Banks are as likely to reduce fixed deposits as they have done on home loans. You could perhaps look at some Income funds - with a 2-3 year view! Instead of a savings account, you should look at a floater fund or a liquid fund if you are not sure of how long you want to keep the monies there - Income funds have an exit load! Also remember dividend distribution tax, short term capital gains tax and income tax while dealing with savings. Investments on the other hand are more tax efficient.
P.V. Subramanyam is a financial domain trainer and can be contacted at firstname.lastname@example.org
The author also runs a blog - www.subramoney.com