Floating rate home loans a safer bet

Likely to cost less than fixed rate loans even after hikes in interest rates.

Owning a dream house, especially in a metro, is certainly an expensive proposition. Some property market surveys, conducted recently, have revealed that the ratio of house prices to average disposable incomes is touching unsustainable levels.

So, when you feel elated and ecstatic at the prospect of owning your dream house, it is equally essential for you to study the implications of key clauses in your loan agreement.

With real estate prices flaring up and banks marking up their prices of home loans, it becomes essential for you to pick an appropriate loan scheme. The key factors to be delved into are many - right from interest rates to a stress-free repayment plan.

Interest rates on housing loans are on the verge of rising. The Reserve Bank of India (RBI), in its mid-term review of monetary policy, increased the rate at which it lends to banks by 25 basis points (one basis point is one-hundredth of one per cent), signalling an increase in short-term interest rates. But the pressure on banks is for hardening of interest rates across the board.

Housing loans are the most finely priced and are most vulnerable to rate hikes in a scenario of rising rates. So, is it a scary situation for home loan seekers as far as floating rate-based loan schemes are concerned? And should they opt for fixed rate loan schemes?

However, going in for a floating rate loan in a scenario of rising interest rates still makes sense. That's because the pricing differential between a floating rate loan and a pure fixed rate loan is about 1 to 1.25 percentage point, in favour of the former. In other words, interest rates on floating rate home loans are always lower than those on fixed rate loans.

Most banks are expected to hike interest rates on home loans by 25 basis points. Currently, housing finance companies charge a floating interest rate in the range of 6.75 per cent to 7.50 per cent for home loans for a repayment period of up to 15 years.

If these banks increase the rates by 25 basis points now and go in for another hike in January (that's when the market is expecting another rate hike by RBI), floating rates on home loans could rise to 7.25-8.5 per cent - a range still lower than that of the current interest rates on fixed rate home loans.

Most banks charge 9 per cent as the fixed interest rate on fixed rate home loans. So, it makes sense to stick to a floating rate scheme or go in for one if you are planning to take a home loan, as the equated monthly instalment (EMI) even after the expected increase in interest rates will still be lower than the EMI under a fixed rate loan.

Also, in the case of a conventional fixed interest rate loan, one might be unaware of the fact that housing finance companies have the right to change the loan's repayment schedules, and terms and conditions, which can have a significant bearing on your overall loan scheme.

And, last but not the least, as it is widely known that 'there is nothing called free lunch', a customer has to pay a handsome price for converting a floating rate loan into a fixed rate loan and vice versa.

And this ranges anywhere from 0.50 per cent to 1 per cent of principal loan outstanding. In absolute terms, for every Rs 1 lakh, the customer has to spend anything between Rs 500 and Rs 1,000.