The year that went by was unmistakably the one for savers with banks increasing their peak interest rate on deposits to 10.50 per cent — a level not seen since the beginning of the New Millennium.

Step into 2009 and it is going to be a year for borrowers, both existing and new.

Though banks had started lower ing lending rates since last month, only new borrowers could avail themselves of the benefits of the rate cut. Existing borrowers were given a miss.

Beginning January 1, 2009, banks started slashing their prime lending rates (PLR) by 0.50 to 0.75 percentage points. Following this, all retail loan rates linked with PLR came down.

The benefit of the lower interest rates will be reflected on the EMI payments of existing borrowers from February.

Bank lending rates are expected to fall further with the Reserve Bank of India going for another round of rate cuts on Friday. The central bank cut the cash reserve ratio — the amount of cash that banks need to keep in reserve — by 0.50 percentage point to 5 per cent.

It also cut repo and reverse repo —the short-term rates at which the RBI lends and borrows from banks — by 100 basis points each to 5.5 per cent and 4 per cent, respectively.

Existing borrowers of bank loans can, therefore, look forward to save more in terms of their EMI outgo in the months to come.

Strategy shift

Now, what should be the strategy of existing borrowers of, say, home loans? Should they ask the bank to lower their equated monthly instalments or should they continue to pay the same EMI and reduce the loan repayment schedule?

Given the current economic scenario, bank interest rates on deposit and lending are expected to remain low for some time — may be for the whole of 2009.

Last year, borrowers were faced with a hike in their EMIs at least thrice following the increases in bank lending rates.

While borrowers struggled to pay higher EMIs, they also had to cope with soaring inflation.

In such a situation, borrowers may be inclined to ask their banks to reduce the EMIs to ease their financial burden. But this won’t be a wise economic decision. It would be better if one continued to pay the same EMI as now while reducing the loan repayment tenure.

Let us explain this.

Last year, higher lending rates and inflation had ripped apart the finances of borrowers.

Excess money supply in the economy had led to the higher prices of products and inflation touched its peak of 12.44 per cent in mid-August. To cool down the economy, the Reserve Bank adopted a tight monetary policy causing lending and deposit rates to rise.

However, within a span of four months, the annual inflation rate slid to 6.38 per cent (as on week ended December 20).

Prized purse

Economists expect the rate to turn negative (prices of commodities falling below the level of the reference period) by the July-September quarter in the current calendar year.

Even if this did not happen, the average annual rate of price increase this year would be around 3 per cent. This would come as a huge relief for one’s daily expenses unlike last year.

Moreover, there is also some respite on the income tax front in the current financial year. The revised income slabs and tax rate for 2008-09 ensure a minimum relief of Rs 4,000 for every taxpayer.

Thus, a lower inflation rate and a reduced income tax burden in 2009 will take away some of the financial burdens of last year.

Now, what should an existing borrower opt for in 2009 — a lower EMI or reduced repayment schedule?

Consider this. If a borrower had taken a home loan three years ago, the EMI must have gone up 20 per cent or nearly Rs 200 per month per Rs 1 lakh borrowed by the end of December.

Banks have announced a 75-basis-points cut in their PLRs, with effect from January 1, 2009. This means the interest rate that an existing home loan borrower was paying till December would turn cheaper by 0.75 percentage points.

This would, however, result in a mere 4 per cent cut in EMI (or a reduction of around Rs 50 per month per Rs 1 lakh borrowed). The savings in EMI will only be more if banks slash their PLRs further.

Tax relief

In the case of a housing loan, there is an additional benefit in terms of an income tax deduction.

While the repayment of the principal loan amount attracts a tax deduction under Section 80C of the Income Tax Act, one can claim the deduction of the annual interest payment up to Rs 1,50,000 from one’s annual income under Section 24.

Thus, by sticking to the same EMI (that one paid in December) payment in 2009, one can claim a higher deduction than settling for a lower EMI.

For new borrowers, loans would be much cheaper now than they were in 2008. A lower lending rate will also increase the loan eligibility of borrowers (how much loan a borrower can get).

However, a cheaper loan alone should not influence one’s borrowing decision.

One must also take into account the price of the commodity that one wants to purchase with the loan, be it a car, a house or a consumer electronic goods .

Till now, only car manufacturers have reduced their product prices. Real estate developers have not lowered the property prices despite a steep decline in input costs, such as steel and cement.

Manufacturers of consumer durables have also been reluctant to reduce prices.

Thus, while existing borrowers can reduce their repayment schedule to take advantage of the lower rate regime, new borrowers can wait for some time before signing up for a loan.