So you think cheap home loans are always best? Stop. Think again. This is only partially true because the advertised interest rate is just one of many criteria that must be looked at when taking a loan. And, in the context of a home loan price war in the market, take time out to understand what these low rates could mean for you and what other factors must be looked at.
Before you zero in on a loan, keep in mind two major factors:
1. Quantitative factors: This relates to the loan amount, the interest rate, the tenure of the loan and the EMI you will be bound to pay contractually.
2.Qualitative factors: This relates to the flexibility your lender can give you under the terms you have signed up for, as well as its service commitment to you as a client.
Taking a home loan is a big decision, and one you could be stuck with for a long time—you are taking on a contractual obligation to repay the loan over a period that could last for 10-20 years. A lot can change during this time—the prevailing economic conditions and market interest rates might change, you might want to move to a bigger home, or prepay your loan if you end up having the means to do so. So, let’s understand how these loans work.
How do cheap home loan rates work?
When a bank or lender announces that it is offering a home loan with a starting rate of 8%, this is the rate that sticks in our minds. However, the first thing that you need to understand is that the headline rate of 8% being offered is just a teaser rate. This rate only exists for a starting period, and after this predetermined time, it resets to a higher rate. The starting period could be anything from one–three years. After this period, the loan adjusts to something higher that you have contractually agreed to at the time of signing or is calculated based on the lender’s internal rate (the lending bank’s prime lending rate or PLR).
So, by the fourth or fifth year, after the initial reset, the rate could be above 10%, and your EMI (equated monthly instalment) might turn out to be higher than what you might be comfortable with.
Past experience from other countries has shown—particularly during the sub-prime crisis in the US—that those who took low teaser rates to buy homes, tempted by cheap rates, were often the ones who ended up in financial trouble a few years later. This is because when the rates adjusted upwards, they did not have sufficient income to pay the higher EMI.
We are not for a moment suggesting that the recent price war using cheap home loan rates will result in an economic crisis in India, or that the banks offering these rates are doing the wrong thing. All we are highlighting is that that there is more to it than meets the eye, and that one shouldn’t make the impulsive decision of going with the cheapest rate.
But isn’t cheap good?
As we mentioned earlier, there are several qualitative factors that need to be looked at.