4 min read.Updated: 23 Dec 2021, 12:11 AM ISTSatya Sontanam
Understanding the features that home loans come with can get you the best financing deal
With interest rates at a multi-year low, it is no doubt a good time to get an attractive deal on home loans. Knowing just the amount of the equated monthly instalments (EMIs) or the interest rate is not good enough. Since home loans run for longer tenures, understanding the features and options that home loans come with can get you a best financing deal.
Here, we talk about three key things to know before selecting a home loan—different types of home loan interest rates, options to customize the home loan EMI and various charges applicable on loans.
Fixed or floating
Banks or housing finance companies (HFCs) generally offer floating rate home loans. Floating rate loans are essentially linked to a benchmark rate and the interest rate applicable on your home loan moves up and down depending on the interest rate movement in the economy.
As per RBI guidelines, floating rate loans issued from 1 October 2019 should be linked to an external benchmark such as repo rate and 3-month/6-month treasury bill yield and must be reset at least once in three months.
Hence in line with the RBI’s rate cut in the past two-three years, bank lending rates too have fallen sharply on home loans.
Meanwhile, there are a couple of banks/HFCs that offer fixed interest rate loans as well. Under this, the rate of interest is fixed either for the entire tenure or a certain part of the tenure of the loan. In case of a pure fixed loan, the EMI and the tenure of the loan will be known in advance and cash outflows can be planned accordingly.
At this juncture, since the interest rates are at a multi-year low and are expected to go up, locking the home loan at fixed rate seems to be an obvious option. However, fixed rate loans command a steep premium for the predictability of cash outflows that it offers.
A look at the interest rates offered by banks/HFCs offering both floating and fixed rate loans show that the latter comes at a premium of 0.7 to 6 percentage points (see table).
The HDFC housing finance company that charges a lowest premium on its fixed rate loans at about 70 basis points (starting at 7.4% per annum) comes with a dual rate scheme. Under this, the lending rates are fixed for the first two-year period, and then moves to a floating rate after that.
Joydeep Sen, corporate trainer - debt, said, “While there is a very high chance that RBI will hike the interest rate by more than 70 basis points in the next two years, this option will still not be significantly beneficial to the borrower as floating rate will be applicable for the rest of the long tenure home loan."
Thus, do your due diligence before choosing the type of loan. Even when you choose a fixed rate home loan, ask if there is any reset clause.
Choose your EMI type
When a floating rate home loan is taken, your EMI may change with the change in benchmark rate.
To avoid changes to EMI amount at every reset, banks may attempt to retain the EMI amount constant but increase/decrease the tenure of the loan.
The choice, however, to increase/decrease the EMI amount or the tenure, rests with the customer.
Ratan Chaudhary, head of home loans, Paisabazaar.com, said, “When the interest rate rises, and if the customer can afford increased EMI, s/he should opt for higher EMI as the loan closes on time and total interest burden comes down."
On the other hand, in the falling interest rate scenario, Chaudhary suggests that instead of choosing the lower EMI, the customer can continue paying the old EMI amount, which helps in closing the loan before the tenure.
Further, some financial institutions also offer flexible repayment options. There are step-up loans, in which the EMI is low initially and increases as years roll by. For example, in case of Bajaj Housing Finance, if a loan is sanctioned for 20 years with step-up EMI option, only the interest is liable in the first two years and for rest of the 18 years, customers have to pay interest along with principal amount.
Similarly, there is also a step-down loan in which EMI is high initially and decreases as years roll by. While step-up option is convenient for borrowers who are in the beginning of their careers, step-down loan option can be considered by borrowers who are close to their retirement years.
Before finalizing a lender, look at various charges such as loan origination or processing charges, administrative charges, documentation, late payment, changing the loan tenure, switching to different loan package during the loan tenure, restructuring of loan, changing from fixed to floating interest rate loan and vice versa, legal fee, technical inspection fee, recurring annual service fee and document retrieval charges.
If it’s unclear, check with the bank about the loan’s annual percentage rate (APR). The APR considers not only the interest rate but also fees and certain other charges that you may be required to pay, expressed as a yearly rate.
If you decide to pre-pay the loan or switch the loan to a different lender, note that there will be no foreclosure charges or pre-payment penalties in case of floating rate loans. The RBI, in 2012, mandated that no fee should be charged in case of pre-payment of home loans based on floating rates.