Should you take a fixed-floating loan?
You can't take a decision on a home loan to just avoid rate changes. There are other factors as well
Since Raghuram Rajan took over as governor of the Reserve Bank of India (RBI) in September, he has raised key policy rates twice by 25 basis points (bps) each to 7.75%. One basis point is one-hundredth of a percentage point.
Short-term rates have eased for banks while medium- and long-term rates remain high. Policy rates and the state of the economy apart, the cost of funds of individual banks will be a key factor in any decision to increase lending and deposit rates, bankers say.
For borrowers, loans have definitely become more expensive, with major banks increasing their lending rates after the monetary policy announcement on 29 October. In such a scenario, some banks have introduced home loans that come with a fixed interest rate in the initial years and floating rates thereafter. Now here’s what this product means and what you should do.
What’s on offer?
Citibank NA is offering semi-fixed rate home loans with interest rates fixed at 10.25%-10.5% per annum till 30 September, 2015; from 1 October, 2015, interest rates will be variable and linked to the base rate. The floating rate will be at the base rate plus 1%-1.25% per annum. This will be available on loans that are booked until 30 November 2013. Says Rohit Ranjan, head of secured lending at Citibank’s Indian unit, “Semi-fixed rate loans provides an alternate option to customers who prefer predictability in interest rates in uncertain times. This offering gives customers stability on their equated monthly instalment (EMI) outflows for the first two years, thus helping them plan finances better and provides protection against fluctuations in interest rates. Though this was not a festive offer, the launch of the product did coincide with festivities as consumers do typically take home loans during this period." The bank says that it will take a decision on extending the offer after reviewing market conditions later in the month.
Hongkong and Shanghai Banking Corp. Ltd, or HSBC, is offering a similar product with a fixed rate at 10.25% per annum for one year; thereafter it will be on a floating rate basis. According to the bank’s website, this loan is available for borrowers whose loan gets disbursed between 5 September and 30 November 2013.
Standard Chartered Plc’s Indian unit is also offering semi-fixed rate loans with the rate fixed for the first three years at 10.26% and floating thereafter. The base rate of the bank is 10.25%. According to the Standard Chartered website, for the three-year semi-fixed home loans, a 2.5% prepayment charges would be applicable in the fixed period.
The fixed rates that these banks are offering is not very high. In some cases, it is even lower than their floating rates. For instance, HSBC is offering home loans with a fixed rate tenor of 10.25% per annum; home loans at a floating rate cost 10.75% per annum.
Do banks benefit from loans that cost lower than the floating rate? Says A. Krishna Kumar, managing director, State Bank of India, “From the banks’ perspective, if they lend at a lower rate and the rates go up, these loans can turn expensive for the banks. So it all depends on market conditions."
What should you do?
You can’t take a decision on a home loan product to just avoid interest rate changes. Interest rates apart, there are various other factors you need to look at when taking a home loan. First, check the prepayment penalty and foreclosure charges. Says Sukanya Kumar, founder and director, RetailLending.com, a loan advisory firm, “Though there is no prepayment penalty on floating loans, banks can charge a prepayment penalty on fixed loans. The prepayment charges can be as high as 2% of the outstanding loan amount."
Second, you would benefit if you check the change in rates once the fixed tenor is over and your loan moves to floating rates. See if you are getting what existing consumers are. Always check the margin amount that will be applicable in addition to the base rate. Next, it is true that loans that are fixed for the initial years will shield you from any rate fluctuations for at least the fixed term. So check your finances and if you feel that even a 25bps increase in rates will pinch your pocket, only then think of looking at fixed products.
Also remember that during the fixed tenor, some banks may also ask you to pay a penalty if you want to switch your loan to another bank.
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