11 Apr 2014

Rupeepower Editorial Team

Home Loans: Where Fixed is Not Fixed and Floating is Not Floating

As one prepares to buy a new home, the question worth pondering over is whether to opt for a fixed or floating (flexible) home loan interest rate. The teaser ads from banks further complicates the issue. However, at the very onset it is important to understand the nuances of the two and then finally take an informed decision.

Fixed interest rate – The term for a layman would simply imply that the rate of interest on the loan amount should remain the same over the tenure of the loan. For instance the fixed interest rate on a home loan worth rs.30 lacs @10% for a period of 20 years should ideally imply that the rate of interest remains the same irrespective of any fall or rise in the interest rates as a result of the fiscal and monetary policy, but in reality and more so in the Indian context this is not the case. In the Indian context home loans whose interest rates could be re-fixed after an interval of 2/3/5 years is also clubbed under the fixed interest rate schema. Ideally we could call it semi-fixed interest rate to differentiate from the true fixed interest rate home loans. A point which a borrower must take care of is that there are some vaguely worded clauses in the loan agreement which literally allows the lender(the bank) to re-fix the prevailing interest rates depending on whims and fancies of the bank. For a borrower signing on such agreement makes no sense and it is better in such a case to opt for a floating interest rate on the loan.

Floating rate loans – As far as the second option of opting for a floating interest rate system is concerned; the major concern arises over the non-transparent manner in which it is determined. It all depends on a benchmark rate and interest on home loans will be charged either at a discount or at a premium of the benchmark rates. The problem with respect to the transparency usually comes to the light when there is a fall in the key policy rates as determined by the central bank but respective banks do not decrease their benchmark prime lending rate or mortgage retail lending rate (as the terminology may be). For instance, if you have opted or a floating interest rate and the bank says that your rate of interest will be at a discount of 1% all seems good. The BPLR say is 11%, so you get your home loan at 10%; the BPLR increases to 12% the floating rate of interest becomes 11%, transparent indeed as your interest rate on the loan is still at a discount of 1% below the BPLR as promises. But consider a case wherein the policy rates have come down, the banks in such a case would not like to pass on the benefits to the consumers and would not decrease their BPLR, implying that despite easing of rates by the central banker your lender is not willing to pass on the benefits to you, this is indeed a question as to how transparent their dealings are. The may pass on the benefit to the new consumers but probably not the existing consumers.

It thus becomes all the more important for a borrower to read the fine prints of the mechanism of determining the interest rate before opting for one. Borrowers also need to understand the fact that one needs to necessarily revisit the decision on the type of interest rate at regular intervals ( it is not a one time affair). This implies that if a borrower has opted for say a fixed interest rate mode, after six months or so depending on the fiscal environment he/she may revisit the decision and perhaps switch to a floating rate system or vice-versa as the case may be.

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