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Effect on Home Loan due to Demonetization

December 9, 2016



Demonetization is the word that took Indians by surprise on 8th November when Prime Minister addressed the nation at 8 p.m. Since then this word has caught up with every citizen & everyone wants to know what impact it is going to have on his/her life. With the current speculation regarding the impact on the real estate sector doing rounds, home loan applicants are a tensed lot of people.

Firstly, for people who have already take home loans there might be an impact on the lending rates at which loans have been taken. Market expectations are that the rates might come down in the near future; as the new policy states that deposit rates might reduce, leading to decrease in lending rates in the near future. This would ultimately result in profiting the individuals. However, the timeframe for loan rates to come down can vary anytime between 3 to 6 months.

In the past, there have been instances where once the repo rate were hiked up by the Reserve Bank of India, the banks too quickly changed theirs. On the flip side, when the repo rates were cut down by the RBI, the banks were slow to respond. Considering this situation, the RBI introduced the MCLR (Marginal Cost of Lending Rate) system. Under this system, the banks must change their interest rates periodically. Thus, under the MCLR system, the interest rates are expected to change at a faster pace. .

Considering the MCLR system, if the home loan is taken under this scheme, then the loan completion period will reduce. This means, loans will be paid off before the actual expected closure dates.

However, if the home loan is taken under the fixed rate of interest scheme, there will be no effect on either the interest rate or the completion date due to the demonetization. The loan has to be repaid at the said interest rate, regardless of the market situation.

Individuals who have taken home loans due to lesser amount in interest, shall repay more in principal & less in interest. In this case, the balance in principal shall be reduced, resulting in lesser amount (in quantum), that needs to be repaid.

Due to the above, more people can apply for home loans, where the difference between the actual loan amount & what we pay on outright purchases is reduced.

Effect on investments

The other investments done in banks, shall fetch reduced rate of investment on a temporary basis, which might change in the long run. Banks are now in a stronger position due to increased deposits and will look for lending options. Due to this need, banks will find prospective customers & being in competitive world, the banks that provide loans at lower interest rates will find more customers.

If an individual makes investment in a firm & the firm gets loans also at lesser rates, the entrepreneur due to higher funds available shall take loans & increase capital. Increase in capital shall lead to higher outputs. This shall lead to higher return on investments, where the investor as well as the firms are in a win-win situation.

Though this step of demonetization in the short run is under stress as we are a highly cash-dependent economy, in the long run finance analysts believe the economy will reap the benefits both from investments in housing as well as corporate sector.