Wrong time to lock into fixed-rate loans

Fixed-floating homes loans are back! This time around though, they come in a different avatar; one that may not be in the best interest of home loan borrowers. These products ‘fix' interest rates at levels higher than rates prevailing on floating rate loans.

Locking into them may be a bad idea, as interest rates look quite likely to fall from here, if not within the next few months certainly within a year or two. The products do not also serve the purpose of assuring borrowers of a fixed EMI given that they would turn ‘floating' after a certain period.

There was a lull in the home loan market after the teaser loans that were offered by most banks were slowly withdrawn, especially after the RBI expressed its concern over such products. But ICICI Bank and more recently HDFC and LIC Housing Finance have attracted attention by launching dual rate home loan products. While ICICI Bank offers a one and two-year fixed rate option, after which rates would float with the bank's lending rates, HDFC offers fixed rates for three and five-year periods.

To gauge whether the product is beneficial for them, borrowers need to look at it in light of the following: one, are these offerings different from the earlier teaser loans? Two, is this the right time to lock into interest rates? Three, as a borrower, is a fixed EMI a priority for you right now?

Not teaser rates

First, the recent products do not appear to be similar to the teaser rate products. Teaser loans offered lower interest rates, relative to floating loan rates, for an initial period of 1-3 years. They then switched you to floating rates linked to the respective banks' benchmark rates.

SBI for instance offered 8 per cent rate for the first year and 9 per cent for the subsequent two years, after which rates would be linked to the bank's base rate. The key point then was that these fixed rates were lower than the floating rates prevailing at that time.

That is not the case now. HDFC's three-year fixed option for instance has a 11.25-per cent fixed rate for loan value between Rs 30-75 lakh, higher than the floating rate of 11 per cent for a similar amount.

The rate difference is more pronounced for a five-year term with difference being as much as 50 basis points. This could mean Rs 1,100-2,000 a month additional outgo for loans between Rs 30-75 lakh.

Agreed that fixed home loan rates, unless meant to ‘tease' you are seldom offered lower than the floating rate, given that they provide the comfort of having to pay a fixed amount as EMI. But then, the timing of entry in to these products matter a lot.

Fixed rate loans offer some benefit only when interest rates are expected to move upward in the medium term.

Borrowers who availed the teaser rates of SBI in early 2008 would have benefitted from the lock-in as rates have been moving up steeply since then.

Whereas now, with slower GDP and lower inflationary pressures, the general consensus is that we may be closer to the peak of a rising rate cycle. Viewed in this background, the fixed rate products do appear more beneficial to the lender than the borrower. A look at the prime lending rate of public sector major SBI for instance, suggests that benchmark rates are at a 14-year high!

In all likelihood, borrowers, especially those going for the three or five-year fixed term products may well lose out on at least one cycle of lower interest rates that would actually cut down their EMI outgo!

Even if borrowers want the comfort of fixed outgo every month, it is noteworthy that the recent products are not entirely fixed. Once they turn floating after the fixed tenure, you would be subject to the vagaries of the market.

Hence paying a premium now, for the temporary assurance of a fixed EMI outgo may not be of much help.

Keeping afloat

In general, the uncertainty that floating rates carry can be overcome if investors go for a loan value that provides them enough leeway for additional outgo.

For instance, if a bank permits say 45 per cent of your gross salary as EMI outgo, you may choose to restrict your loan value so that 35-40 per cent of the gross salary goes into EMI.

This will ensure that you can bear any additional outgo. If this is not workable, you can always choose to keep the EMI fixed and extend the loan tenure.

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