When you take a home loan, you have a choice between taking a floating interest or a fixed interest home loan.
As the name suggests, a fixed interest home loan does not change over the entire tenure of the loan. Let us understand this with an example.
Floating interest rates on home loans work differently
Floating interest rates on the other hand, do not work on the same principle. The interest rate keeps changing according to market conditions and this brings the EMI up or down depending on the bank. Most of the time, the interest rates are aligned to the prime lending rate. When the prime lending rate goes up, the EMI may go up and so on.
But, what moves the floating interest rates higher or lower
The one and the biggest factor that moves floating interest rates in either direction is the Reserve Bank of India credit policy.
When the Reserve Bank of India feels that inflation is heading higher it will hike the repo rates. Repo rate is the interest rate at which the RBI lends money to banks. When it hikes the rates, the cost of money to bank goes higher and they hike interest rates.
This may not always happen, but, most of the time it does. On the other hand when the Reserve Bank of India feels that inflation is falling it may reduce interest rates to boost growth in the economy. This is when your floating interest rate on home loan would change.
We wish to emphasize once again that this is not the only factor that leads to a change in home loan EMIs, because of a change in floating home loan rates. Banks may or may not change interest rates, based on a change in the RBI's repo rate.
Another important aspect is that Bank's also analyze their own asset liability mismatch before deciding on interest rates.
Also, there are various other factors that also come into play before a change in interest rate. For example, though the RBI has reduced repo rates by 150 basis points in the last many quarters, banks have not cut interest rates by similar amount. This is because they are saddled with non performing assets, which may have weighed on their decision.
So, it is not always repo rates, though it maybe the single most important factor that affects floating home loan interest rates in India and hence your home loan EMI.