Reserve bank of India reduced the Repo rate from 8% to 7.75% on 15th January. 2015 in a surprise move. How this rate cut will affect your personal finance?
Will the rate cut affect my interest on fixed deposit? Will I get more returns from equity if interest rate is reduced? When can I expect reduction in my home loan EMI? Will this help in reducing inflation and help in reduction of my household expenses? Investors and borrowers are having many concerns on the interest rate cut by RBI.
What is Repo rate?
Repo rate is the rate at which Reserve Bank of India lend money to banks. A reduction in repo rate will help the banks in getting money from RBI at a lesser rate. This will help in reducing the lending rate so that you can expect reduction in loan rates in the coming days. But banks may take some time in passing this benefit to you because they have to improve their balance sheet first.
How the rate cut will affect you? How you should plan your investment /borrowing ?
The effect of rate cut will be different for different class of people. If you are retired and is living on the interest income from deposit, the rate cut will affect you badly. But if you have a home loan, then reduction in EMI will help you. Let us see the effect of rate cut on various instruments and see how you can do the best for optimum benefits.
- Fixed Deposit: The banks will reduce the deposit rate before reducing the lending rate to protect their profit margin. So, you can expect the reduction in deposit rate anytime soon. If you have surplus, this is the time to lock it in long term FD at the best rates available. Corporate deposits are still attractive. But look at the credit rating before investing. Avoid low rated deposits and NCDs because of the default risk.
- Recurring Deposit: If you are planning to build a down payment for a house purchase in the next 3-4 years, you can look at recurring deposit. The RD booked for 3 years at 9% interest now will pay the same rate of interest for the 3 years, even if there is a reduction in interest rate later. But remember that the interest on RD and FD are fully taxable as per your tax slab.
- Bond Funds: With reduction in interest rates, the return from short term bond funds will be lower in 2015. But the long term bond funds will attractive in a rate cut regime like this. These funds have given handsome returns in 2014, expecting a reduction in interest rate. These funds can give good return in 2015 also, if there are more rate cuts. But the trend may reverse when the interest rate start increasing. You must book profits at the right time, if you want to play on this theme. 3 year Fixed Maturity Plan (FMP) is also a good option because of the indexation benefits.
- Equities: India is now having many factors supporting the growth in equities. Low oil prices, improvement in Current Account Deficit (CAD) and Fiscal deficit, ease in inflation and reduction in interest rate etc will support the ongoing bullish trend in the equity market. Though there can be volatility due to global factors, the outlook remains bullish in the long term. It will be an ideal time to invest more in equities .If you are not an expert, do it through SIPs in mutual funds.
- Auto Loan and personal loan: If you are planning to go for such loans in near future, please wait. You may get a better deal, if you wait for few months. Also do a hard bargain with the lender before deciding. Banks may soon reduce the auto loan rates to revive the weak automobile sales.
- Home loan: Home loan rates are very competitive and are linked to the base rate. A reduction of 25 basis points may not reflect in the home loan rate now. If you are planning for a home loan, it will be better to wait for another round of rate cut and then decide the best option. If you are already having a home loan and is planning to switch the home loan, it will be better to decide on the lender after one more round of rate cut. Opt for floating rate home loans because you will get the benefit of further rate cuts in future. Some lenders are pushing fixed rate home loans now. It will not be good for you now.
As an investor in Debt you may lose out on interest now but an equity investor may gain on rate cuts. Potential borrowers will be happy on the rate cuts due to lower EMI burden. Rate cuts will support the growth in most sectors and the effect of lower inflation will help everybody. Let us wait for that Achhe Din.