Fixed loans: Beware of force majeure

Home loan takers might be inclined to go for the fixed rate option today under the presumption that interest rates will not go down in the foreseeable future.

But remember, the fixed loan that you are taking may not be really fixed, as in an unchangeable interest rate.

A careful scrutiny of your loan document could reveal a legal loophole that allows the home loan company to 'unfix' and raise the rate under exceptional circumstances. It's called the 'force majeure' clause.

Force majeure "" French for great force "" is a standard clause in many commercial contracts. Typically, it covers natural disasters or other "Acts of God", war, or the failure of third parties "" such as suppliers and sub-contractors "" to perform their obligations to a contracting party.

And if you do find one, it's time to reassess your home loan options because other banks/ housing finance firms may not have that rate hook. Specifically, look at the examples cited whereby the clause can be invoked "" if it talks about the above examples, fine, there is no issue. But if the clause contains subjective examples such as money market volatility, drop the offeror.

It is important to remember that the force majeure clause is intended to excuse a party only if the failure to perform could not be avoided by the exercise of due care by that party.

In the present instance, it gives the bank or housing finance firm the power to change the interest rate on a fixed rate loan under unusual circumstances.

For example, if you have just taken a 7.75% fixed rate loan and after two years, if the interest rates in India shoot up, your housing finance firm could just jack your loan rate to 10% without batting an eyelid.

Although banks are quick to say that the clause means nothing and is a mere legal formality, it is better avoided. The bank official will reassure you saying, "We will never invoke the clause. There's nothing to worry about." But then, why have a clause which only favours the lender when ideally these clauses are meant to benefit both parties involved?

Housing Development Finance Corporation (HDFC), LIC Housing Finance and recently ICICI Bank are some players that offer fixed rate loans without the force majeure clause. A lot of other banks have it as a matter of routine.

As a customer confidence building measure, ICICI Bank, the fastest growing housing financier in the country, recently removed the discretionary power it earlier had to raise rates on its fixed rate home loans.

This would mean that for all ICICI Bank's fixed rate home loan borrowers, the rate will actually remain fixed for the entire term of the loan and will not go up under any adverse circumstances.

A few weeks back, HDFC introduced a product with a force majeure clause called the Money Market Product. On this product, the mortgage leader reserves the right to raise interest rates under 'extreme circumstances'.

Earlier the housing major gave only fixed rate loans that remain remained fixed for the entire tenor of the loan.

The short point is, with such a clause in place, a fixed rate loan can behave like a floating rate loan.

This is helpful for the borrower when interest rates go down but when rates head northwards, it can have a painful fallout "" the EMIs or the instalments increase.

Basically, a force majeure clause is meant to benefit both parties to a contract. But in Indian home loan documents, you will observe that it favours only the lender.

So when negotiating a force majeure clause, it is important to ensure that the clause applies equally to all parties to the agreement and not just to the licensor.