Taken together, these factors mean that a borrower can now:

Lock into a low fixed rate of interest and get the benefit of any decline in interest rate by refinancing, or

Contract floating rate loans at low rates and minimise the impact of a rise in interest rates by refinancing.

Either way, the borrower can now lock into low rates. Later, if interest rates decline, he can take advantage of that too. In addition, it can also be ensured that rising interest rates do not make much of an impact. Such deals reduce the risk that a home loan poses to a borrower's financial security.

Caveats: Refinancing is necessary

However, this picture of home loans as an all-weather financial arrangement is subject to the borrower being ready to exercise the option of refinancing. Refinancing refers to the takeover of existing home loans by another lender.

Suppose you have taken a home loan from HDFC. Three years into the loan, you can transfer the loan to SBI. The takeover of the loan by SBI from HDFC is called refinancing.

Refinancing is necessary because housing finance companies incorporate restrictive clauses. They are:

In the case of fixed rate loans, lowering of contracted rate is not possible if interest rates decline.

Refinancing helps overcome this by paying off the existing loan and contracting a fresh one. Of course, the exception being ICICI and SBI, which do allow for resetting the interest rate so that a borrower need not resort to the refinance option.

In floating rate loans, switching to a fixed-rate loan is not possible, except in ICICI.

Importantly, even those who allow such conversions now may not offer them in the future.

These restrictive clauses ensure the necessity of refinancing in the event of substantial changes in interest rates.

If interest rates decline sharply, refinancing is necessary for fixed rate home loans. If interest rates rise sharply, refinancing will become necessary for floating rate home loans.

The big plus, however, is that refinancing is not expensive now. It can be done at a cost of 2-3 per cent of the principal outstanding.

As such, refinancing will be of benefit even if the interest rate declines only 0.5 percentage points from the present level for fixed rate home loans. If the interest rate falls by 1 percentage point, the benefits from refinancing will be substantial.

There is, of course, a catch. For instance, in ICICI, the costs of refinancing can be revised upwards later. So, if liquidity in the system dries up, ICICI can revise the refinancing penalty upwards. In HDFC, SBI and LIC Housing Finance, the refinancing cost is written into the contract and cannot be changed. In other words, the refinancing cost is capped at the rate mentioned in the contract and cannot be revised upwards.

Go for fixed

Theoretically, the deals on offer suggest that the risk of choosing floating rate loans is not as high as choosing a fixed rate loan. Suppose you have contracted a floating rate loan at 7.5 per cent for 15 years. Let us also assume that interest rates rise by 1 per cent to 8.5 per cent after three years and you want to migrate to a fixed rate loan at 9 per cent.

If the cost of refinancing were 3 per cent of the principal outstanding, then for the entire tenure of 15 years the cost of the loan would work out to 8.6 per cent only. This compares favourably with the effective cost of 8.3 per cent for a 15-year fixed rate home loan now.

So, even if interest rate rises three years from now, you can mitigate the impact considerably by refinancing. Therefore, a floating rate loan, which will benefit you if interest rates decline, appears more competitive than a fixed-rate home loan.

However, this is only in theory. If you contract floating rate loans, you are vulnerable to sharp spikes in interest rates within a short period. For example, in the UK, in 1988, interest rates rose from 7.5 per cent to 13 per cent in just six months.

Of course, the probability of such an extreme event is significantly low. But you never know. So, opting for floating-rate home loans now does come with risks.

As such, locking into fixed-rate loans at an interest rate of 8 per cent appears the better option.

In addition, if interest rates decline by 1 percentage point, you can either lower the contracted rate or refinance the loan by paying a fee.

Choosing the lender

The four biggest players in the home loan business are ICICI, SBI, HDFC and LIC Housing Finance. Invariably, these four offer the best deals in the market.

In terms of interest rates on floating rate loans on offer, there are other competitive players, such as IDBI Bank, ABN Amro and CitiBank.

The deals offered by others, such as Bank of Baroda, Corporation Bank, Canfin Homes and Punjab National Bank, do not appear exciting based on the advertised interest rates. However, you might land a good deal even with these banks if you negotiate hard.

Better service: In terms of service, the difference appears to have narrowed considerably, especially among the top four players.

The documentation requirements have been comprehensively detailed on the Web site, and the procedures, such as obtaining a lawyers' opinion, are streamlined.

The front-loaded fees are also more or less uniform, and range between 0 per cent to 0.5 per cent. Importantly, even such fees are advertised as one per cent, you can negotiate and bring them down to 0.5 per cent.

In this context, the rate on offer, terms for lowering interest rates and prepayment will decide which lender offers the best value.

Floating rates: In the case of floating interest rates, ICICI, LIC Housing Finance and IDBI Bank offer attractive deals with rates at 7.5-7.75 per cent. LIC Housing's product appears to have the edge.

This is because there is no prepayment or refinancing penalty after five years. Importantly, the penalty of 1.5 per cent for prepayment within five years is written into the contract and cannot increase. In addition, the floating rate is changed every six months and is the same for existing and new borrowers.

Fixed rates: In fixed rate loans, ICICI, SBI and HDFC offer the best deals. Other loans are downright unattractive on the interest rate front.

However, the HDFC scheme suffers slightly in comparison, in that it does not allow lowering of contracted rates.

SBI and ICICI offer lowering of contracted rates by paying a fee.

However, lowering of the contracted rate may not be allowed in future when borrowers want it the most. Therefore, there is little to differentiate between the three.

The best quote should guide the decision. So, go ahead and sew up your deal for that home which has all along remained elusive because of imposing finance costs.

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