While the year 2008 was marked by frequent instances interest rate fluctuations followed by a lull and then stability- year 2009 seems to be all about increasing interest rates.
So, what is it that a home borrower should do? Should he latch himself to the transient safety of fixed interest rates or surf the highs and lows of a floating rate. This is the classic dilemma.
Before we jump to that, let’s see what these two interest rate types essentially are. A pure fixed interest rate is a rarity in the market today. This kind of interest rate remains fixed for the entire tenure. This is unlike the fixed interest rate that major home loan lenders offer today.
If you take a look at the schemes offered by major players of the home loan market, the fixed interest rate is applicable for a preset period after which the current floating rate is applicable. In reality, these schemes are bringing out the true essence of the fixed rates. No fixed rate offered today is truly fixed.
The other popular loan interest type is the floating rate, one which gets changed based on the market conditions.
So what does one really do? The questions have come to haunt consumers back again. And, its not surprising. Most banks are engaged in cut-throat competition, especially evident in the last years. Be it the stimulus package loans or schemes like State Bank of India’s Happy Home scheme, there’s lots being done to promote the home loan sector.
This sector, which otherwise is robust in growth, has suffered setbacks, recently. Banks have become cautious about lending to customers with a weak profile. And, loan consumers are wary of loans. The recession has of course changed their priorities.
But for those who take loans, floating IS the option.
For one, most of the new schemes offered by the banks are FIXED ONLY FOR A CERTAIN PERIOD. And, they are floating interest rate schemes.
Around December 2008, public sector banks announced the stimulus package for loans Loans up to Rs 20 lakh will now be available at 8.5-9.25 per cent a year for tenures up to 20 years. The offer was valid only for new loans up to June 30, 2009. This was around the time when the interest rates on these loans were an average of around 10 per cent for most PSU banks. This new offer was for ‘floating interest rates’.
Under the scheme, the interest rate on home loans up to Rs 5 lakh, for a maximum period of 20 years, will not exceed 8.5 per cent for the first five years. The margin for this segment has been reduced to 10 per cent, from the current 20-25 per cent. This means a borrower can get loans up to 90 per cent of the value of the house. The interest rate on loans up to Rs 20 lakh for a maximum period of 20 years has been fixed at 9.25 per cent and the margin has been reduced to 15 per cent.
For the first five years, if any bank introduced a home loan product at a lower rate, then the borrowers will be eligible for that rate. After the first five years, the interest rate will be reset from the date of the first EMI payment and borrowers have the option to go for fixed or floating rates.
The package does not apply to existing home loan borrowers and cannot be swapped with an existing loan.
The competition moved a notch higher with SBI’s Happy Home Scheme announced around January 2009, with home loans at a floating rate 8 per cent, fixed for the first year and floating thereafter. The good thing is that this offer was not restricted to a particular loan bracket. Again this is a scheme for floating rates.
While a rate increase seemed to be the order of the day, rate cuts by two major home loan market players came as a surprise.
Earlier this month, i.e. Juky 2009, SBI revised its home loan scheme for new customers . New borrowers would get loans at 8% for the first year and 9% for the second and third years. From the fourth year, the interest rate would be linked to the bank’s prime lending rate. This is also a unique floating rate loan with an element of fixed interest rate.
Another surprise was the HDFC Ltd. rate cut announced on July 21, 2009. the housing finance arm cut lending rates for new customers by 25-50 basis points. It restructured its loan baskets to create a new product where loans up to Rs 15 lakh are available at 8.75% as against 9.25% earlier.
As per the revised structure, loans between Rs 15 lakh and Rs 30 lakh are now available at 9% (against 9.25% earlier) and loans above Rs 30 lakh are priced at Rs 9.5% (9.75%). Following the reduction, the EMI on a Rs 1-lakh loan with a 20-year tenure will shrink to Rs 884.
However, HDFC’s prime lending rate (PLR) remains unchanged at 13.75%. so, the new rates are specifically for new borrowers not the existing ones. There will be no change in EMIs or cost of fund.
If one is to consider the cut, a 50-basis point reduction in the interest rate lowers EMI by around Rs 34 for a Rs 1-lakh loan.
In the present round of cuts, HDFC has reduced rates for new borrowers under its floating rate scheme by widening the spread between the PLR and loan rate.
So,if one looks carefully, there is a pattern. Most banks offer rate cuts for floating rate homes, whether old or new. And, the most recently introduced unique ‘fixed’ component coupled with a floating interest is an attractive innovation.
Besides the recent developments, floating rates are always a better option.
For one, these loans are at least 2% cheaper than a comparative tenure fixed rate housing loan.
Also, the floating interest rate borrowers community is significantly large. Keeping the numbers in mind, the government is likely to make any such policy decision that is likely to lead to a sudden or drastic increase in home loan rates of this interest rate type.
If opting for floating rate home loans, the consumer may benefit from the reducing interest rates as (not if) and when the interest rate cycle turns and commences on its downward journey. Even if the interest rates rise, in the interim as long as they do not rise above the 1.00% differential; you are still a net gainer.
Earlier in the discussion it was pointed out that there is nothing like a ‘pure’ fixed interest rate that is being offered by any lender in the Indian market. So, floating rate are the best bet.