How Do Interest Rates Impact Real Estate?

Money is the prime concern when one decides to buy a home. Earlier in India, people saved for all their lives to purchase a residential property in India at the end of their careers. As a result, while most ended up spending their youths in rented places, they did not have a bank loan to worry about. The current generation relies heavily on bank loans to fulfil its home dreams right in their youth. Naturally, the loan remains a worry, as there are many factors that decide constant changes in your home loan.

Here are some basics for those who take a home loan:

What are interest rates? Simply put, interest rate is the cost of borrowing money from a bank. A bank decides the interest rate at which it lends, depending on many factors, including credit worthiness of a borrower and most importantly, the base rate. A bank decides the interest at which they give a loan, depending on many factors, including credit worthiness of a borrower and most importantly, the base rate. A base rate is the minimum rate at which banks are permitted to lend money. The prevailing interest rates in a country determine the health of the economy. Interest rates are among the most significant factors that influence the real estate market, directly as well as indirectly.

What is the RBI's monetary policy? Banking regulator Reserve Bank of India (RBI) determines the interest rates prevailing in the system. Every quarter, it revises or keeps key rates unchanged. These key rates are repo rate, the interest rate at which RBI lends money to banks, and reverse repo rate, the interest rate that RBI pays when it borrows money from banks. These two rates determine the eventual interest that you will be paying and, hence, make an impact on your EMI. This is especially true, if you have taken a loan on a floating interest rate, where the banks revises the rate and changes the EMI that you pay, regularly. The other option is fixed interest rate where a certain rate is charged for certain number of years. Every change in monetary policy, however, might not have an immediate effect. For example, in the last few quarters, banks have not cut rates in spite of small cuts announced by RBI. A few banks later passed on the rate cut benefit sparsely after a strong statement by the banking regulator. Fluctuating interest rates will also make home buyers wait and watch until they stabilise, affecting demand.

A look at how different aspects of real estate get impacted by the interest rate:

Demand for real estate Around 90 per cent of the homes are partly paid for with loans from banks. If prevailing interest rates are high, taking a loan becomes costlier. This would in turn reduce the demand for real estate. However, buyers who look to buy property with cash, this could turn out positive. Such buyers are small in numbers though. Impact on builders: Higher interest rates would make loans more expensive for real estate companies, too. A number of realty companies are burdened by debt, and a further raise in bank loans would not only burden them further but also impact new project launches. Impact on home owners: Home owners, who are already paying equated monthly instalments (EMIs) , will be burdened further if the interest rates rise, especially in case of loans based on a floating interest rate. If the interest rate cycle remains towards the higher side for a longer time, it will make the property much costlier than what it is intended to be.

Value of your property The value of a property is not directly impacted by a hike or a reduction in interest rates. But, if interest rates remain high for a very long time, it will have a detrimental impact on the realty demand. If this situation remains persists for a long time, capital appreciation of a property will be much slower than expected. That will bring down value of a home. A low interest rate regime will also not have any immediate positive effect on the value of homes, as it is determined by a variety of factors.

Economic scenario Interest rates determine many factors of the economy such as capital availability and investment in the country. This will determine the general well-being of the country hence affecting the sentiment. 

(Katya Naidu has been working as a business journalist for the last nine years, and has covered beats across banking, pharma, healthcare, telecom, technology, power, infrastructure, shipping and commodities)