The past few days have seen experts talk of a high interest rate scenario. With respect to home loans, we have already seen a few housing finance companies increase their home loan rates.
Some have decided to adopt a wait and watch policy. This note takes a closer look at the options available to home loan borrowers in such a scenario.
In our view, the current rise in interest rates may not be a secular trend as many people believe. Rates may have risen for a few HFCs but we there is nothing to suggest that this is going to be a long term trend.
Also hardening of interest rates may not necessarily translate into a rise in home loan rates. Some companies could well decide to raise rates marginally as quite a few have already done, while some could keep it unchanged at least in the near term as some HFCs like ICICI Bank seem to have done.
The steep competition in the home loan industry is one reason why higher interest rates do not always lead to higher home loan rates. Marginal interest rate hikes are usually absorbed by the HFC. This is because an HFC by keeping rates competitive in a high interest rates scenario could grab more clients from peers who have raised rates on their home loan offerings.
So what does all this mean for the home loan seeker? What should he do in such 'uncertain' times?
We believe that interest rates may rise in the near term leading to an increase in the cost of borrowing for home loan seekers. In such a scenario, individuals can always evaluate the fixed rate (fixed for 3 years) option. That way, the individual can lock his loan at prevailing interest rates, which could be lower than what one might see 3 years hence.
Individuals also have the option of considering fixed rates (fixed for 5 years) -- however, the interest rates for loans under this option are slightly higher by around 50 basis points as compared to the 'fixed for 3 years' option.
Another alternative for the individual is to opt for a floating rate loan. Floating rates are usually 75-100 basis points lower as compared to fixed rates. However, the EMI payable on the home loan is (usually) not altered by most HFCs, what changes is the tenure, which fluctuates depending on the interest rate movements Usually, the tenure goes up by 9-12 months for every 25 basis points rate increase.
And since it is observed that home loans are pre-paid usually within 10-12 years, the impact of the interest rate oscillations tends to have a lower impact.
Of course, all said and done, the decision on whether to opt for a fixed or a floating rate of interest depends on the individual's risk appetite and his understanding of the economic environment. If an individual believes that rates are headed northwards for some time to come, then he can lock himself into a 'pure' fixed rate loan.
However, he will not get the benefit of a fall in rates, if this was to happen in the future. Individuals who don't have a long-term view on interest rates, but believe that home loan interest rates could rise in the short term, should opt for the fixed rate loan, which is subject to revision periodically. This way he will have capped his EMI liability to a pre-determined level.
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