 "Opt for fixed rate loan for shorter tenure")
When buying a home, most borrowers go through the dilemma of choosing between a fixed and a floating rate loan. Now, that interest rates are on a downward spiral, taking a fixed rate loan might not look prudent. It can, however, work out to be more cost-effective if you are going for a short-term loan, less than seven years.
Trend
The 2008 global meltdown, along with other macro- and microeconomic factors, pushed the 2003-04 interest rate of seven-eight per cent to 12-13 per cent by 2010. And, the trend continued till 2014.
With increasing inflation and higher interest rates, fixed rate loans had almost disappeared from the market. Borrowers continued with floating rates, hoping for a downward revision by the banks.
During the high interest rate regime, many banks offered teaser loans, which were fixed for a pre-defined period - say three to five years - and thereafter the loan switched to floating interest rates. These products did not manage to break the monopoly of floating interest rate loans due to the complexity of their terms and conditions.
Of the four RBI bi-monthly monetary policy reviews this year, the first three rang in repo rate cuts of 25 basis points (bps) each, and the fourth review on September 29 saw a further policy rate cut of 50 bps, bringing the repo rate at 6.75 per cent. As a result, home loan interest rates of most banks have come down.
On Offer
Axis Bank has a lifetime fixed-rate home loan at 11.75 per cent for 20-year tenure. HDFC offers a TruFixed Plus loan with fixed interest that ranges from 9.6-10.15 per cent. IDBI Bank offers at 10.50 per cent for loans below Rs 30 lakh and 10.75 per cent for loans in excess of Rs 30 lakh. PNB Housing Finance charges 9.95-10.15 per cent. ICICI Bank interest rate is at 9.6-9.95 per cent.
Fixed-rate home loans, unless otherwise specified, do not mean that the rates will remain same for the entire loan tenure. ICICI Bank, for example, offers a fixed rate loan that resets after five or 10 years. HDFC Bank offers fixed rate loan that resets every two or three years (depending on borrower's choice), while PNB's fixed home loan is reset every five years.
Some banks offer fixed loans with a reset clause specifying that in case the market rate increases beyond a certain specified number, the bank will revise the rates accordingly. Such clauses will be specified in the loan agreement.
Fixed vs floating
Fixed interest rate loans don't save money in the long run. Rather a borrower should opt for floating home to get higher benefit, as home loan is a long-term commitment.
Consider three scenarios. A person takes a loan of Rs 50 lakh for a period of 20 years at an interest rate of 9.6 per cent.
Scenario 1: Fixed rate loan
Here, the interest rate stays the same throughout the tenure. The equated monthly instalment (EMI) would come to Rs 46,934 and the total outgo including principle and interest payment over 20 years would be Rs 1.12 crore.
Scenario 2: Floating rate loan
Assume that the rates come down to 8.5 per cent after 12 months. The loan outstanding at that point would be Rs 49.13 lakh and balance tenure would be 228 months. The EMI would come down to Rs 43,502.
Say after five years, the rates move up to 10.5 per cent due to macroeconomic developments. After 60 months, the outstanding balance would be 42.65 lakh and the balance tenure is 168 months. The EMI would be revised to Rs 48,555.
The total outgo over 20 years in this scenario would be Rs 1.13 crore (Rs 46,934 X 12 months + Rs 43502 X 60 months + Rs 48555 X 168 months). In effect, fixed rate loan turns out to be cheaper by Rs 66,888.
Scenario 3: Fixed term (5 years)
Here, the initial 60 months attract an EMI of Rs 46,934. Thereafter, the interest rate would change to floating and would be pegged to the then prevailing rates.
Say the floating rate after five years is 10.5 per cent. The EMI then goes up to Rs 49,397 and the total outgo would come to 1.17 crore (Rs 46,934 X 60 months + Rs 49,397 X 180 months). In effect, this is expensive by Rs 4.44 compared to the fixed rate loan.
In the above examples, interest rates fluctuations are assumed. In reality, they actual rate movement would vary.
It would make sense to opt for fixed rate loan only if you are planning to borrow for a short tenure of five to seven years. No one can predict how the interest rate cycle will be after five years. Also, you should be comfortable with the prevailing rates and EMIs, and should be able to make part pre-payments.
A home loan is a long-term financial commitment that spans over a period of 10-20 years. Choose wisely.
FIXING IT HELPS
Trend
The 2008 global meltdown, along with other macro- and microeconomic factors, pushed the 2003-04 interest rate of seven-eight per cent to 12-13 per cent by 2010. And, the trend continued till 2014.
With increasing inflation and higher interest rates, fixed rate loans had almost disappeared from the market. Borrowers continued with floating rates, hoping for a downward revision by the banks.
During the high interest rate regime, many banks offered teaser loans, which were fixed for a pre-defined period - say three to five years - and thereafter the loan switched to floating interest rates. These products did not manage to break the monopoly of floating interest rate loans due to the complexity of their terms and conditions.
Of the four RBI bi-monthly monetary policy reviews this year, the first three rang in repo rate cuts of 25 basis points (bps) each, and the fourth review on September 29 saw a further policy rate cut of 50 bps, bringing the repo rate at 6.75 per cent. As a result, home loan interest rates of most banks have come down.
On Offer
Axis Bank has a lifetime fixed-rate home loan at 11.75 per cent for 20-year tenure. HDFC offers a TruFixed Plus loan with fixed interest that ranges from 9.6-10.15 per cent. IDBI Bank offers at 10.50 per cent for loans below Rs 30 lakh and 10.75 per cent for loans in excess of Rs 30 lakh. PNB Housing Finance charges 9.95-10.15 per cent. ICICI Bank interest rate is at 9.6-9.95 per cent.
Fixed-rate home loans, unless otherwise specified, do not mean that the rates will remain same for the entire loan tenure. ICICI Bank, for example, offers a fixed rate loan that resets after five or 10 years. HDFC Bank offers fixed rate loan that resets every two or three years (depending on borrower's choice), while PNB's fixed home loan is reset every five years.
Some banks offer fixed loans with a reset clause specifying that in case the market rate increases beyond a certain specified number, the bank will revise the rates accordingly. Such clauses will be specified in the loan agreement.
Fixed vs floating
Fixed interest rate loans don't save money in the long run. Rather a borrower should opt for floating home to get higher benefit, as home loan is a long-term commitment.
Consider three scenarios. A person takes a loan of Rs 50 lakh for a period of 20 years at an interest rate of 9.6 per cent.
Scenario 1: Fixed rate loan
Here, the interest rate stays the same throughout the tenure. The equated monthly instalment (EMI) would come to Rs 46,934 and the total outgo including principle and interest payment over 20 years would be Rs 1.12 crore.
Scenario 2: Floating rate loan
Assume that the rates come down to 8.5 per cent after 12 months. The loan outstanding at that point would be Rs 49.13 lakh and balance tenure would be 228 months. The EMI would come down to Rs 43,502.
Say after five years, the rates move up to 10.5 per cent due to macroeconomic developments. After 60 months, the outstanding balance would be 42.65 lakh and the balance tenure is 168 months. The EMI would be revised to Rs 48,555.
The total outgo over 20 years in this scenario would be Rs 1.13 crore (Rs 46,934 X 12 months + Rs 43502 X 60 months + Rs 48555 X 168 months). In effect, fixed rate loan turns out to be cheaper by Rs 66,888.
Scenario 3: Fixed term (5 years)
Here, the initial 60 months attract an EMI of Rs 46,934. Thereafter, the interest rate would change to floating and would be pegged to the then prevailing rates.
Say the floating rate after five years is 10.5 per cent. The EMI then goes up to Rs 49,397 and the total outgo would come to 1.17 crore (Rs 46,934 X 60 months + Rs 49,397 X 180 months). In effect, this is expensive by Rs 4.44 compared to the fixed rate loan.
In the above examples, interest rates fluctuations are assumed. In reality, they actual rate movement would vary.
It would make sense to opt for fixed rate loan only if you are planning to borrow for a short tenure of five to seven years. No one can predict how the interest rate cycle will be after five years. Also, you should be comfortable with the prevailing rates and EMIs, and should be able to make part pre-payments.
A home loan is a long-term financial commitment that spans over a period of 10-20 years. Choose wisely.
FIXING IT HELPS
- Take a fixed rate loan for tenure lower than seven years
- It saves borrowers from fluctuations
- Interest rate difference between fixed and floating loan should be less than 1 per cent
- Current offerings range from 9.6 per cent to 11.75 per cent
- Not all loans in this category are fixed for entire tenure
- It can be changed to floating after a particular period
- Some can be revised if interest rate surpasses certain limit
The writer is CEO, BankBazaar