The market for home loans has been sizzling in India. The spurt in growth in recent years and the prospects of continued buoyancy in demand have attracted many players to the industry, which till a couple of years back had two major players - HDFC and LIC Housing Finance.
The result -- cut throat competition, which has benefited the loan seeker.
The home loan market has grown at a compounded rate of over 40% over the last four years. And from what industry experts will have us believe, there is little chance that there will be any significant decline in growth rates going forward.
So what have been the key factors in triggering of this high growth period?
There are several reasons for the same.
On the demand side:
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Faster rise in incomes as compared to property prices, thus making housing more affordable.
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Declining interest rate, which has greatly reduced the cost of servicing a loan.
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Tax benefits, which further reduced the effective cost of borrowing (both on interest and capital).
Then there are factors on the 'supply side' too which have supported this growth:
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More competition in the housing finance sector resulted in companies charging lower interest rates, sometimes even at the cost of the spread (i.e. profit margin).
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The fee for getting a home loan has reduced dramatically over the last couple of years, from over 2% of the loan amount to as low as 0.25% (some companies are known to waive off the fee entirely!).
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Housing finance companies have introduced several new products to meet the needs of a wide variety of customers. One such scheme, the step up loan, where the EMIs increase as the income of the individual increases has been a big hit with individuals just starting off with their careers.
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One other factor is the increasing collaboration between housing finance companies and builders. Such partnerships minimise service and funding related issues significantly, thus making it easier to buy property.
(*Companies are known to offer varying rates on case to case basis. The rates are for an Rs 10 lakh loan for a 15-Yr term)Company Floating Rate (%) Fixed Rate (%) Bank of Baroda 8.25 9.00 Canara Bank 8.00 9.00 CITIBANK 7.25-7.50 8.00 HDFC (Monthly) 7.75-8.25 7.75-8.50 HSBC 7.50 NA ICICI 7.50 7.75 IDBI Bank 7.50 NA LICHFL 8.50 9.50 SBI 8.25 8.25
One innovation in the housing finance sector has been the introduction of 'floating rate' home loans. Simply put, the cost of such loan, or the interest rate, is not fixed during the tenure of the loan. Instead the interest rate is benchmarked against some index/indicator.
So as the benchmark rate moves up/down, the cost of your loan too changes, at some predetermined frequency (usually once a quarter).
Ideally, loan seekers should opt for a floating rate home loan when it is expected that interest rates will decline going forward. Fixed rate loans should be preferred when interest rates are expected to rise.
But is making a choice that simple? In today's environment, when there is a lot of talk about rising interest rates, should investors shun floating rate home loans altogether?
Or is there still some merit in this instrument? "In the last one year, there was a trend of floating rate home loans being more popular as compared to the fixed rate loan. As of now, this trend is continuing." says Suresh Menon, GM (Mumbai Region), HDFC Ltd.
There are three important issues which one needs to consider before opting for one type of a loan over the other.
First, an important determinant of what you go in for should be the long-term expectation of interest rates. For example, if you (or the experts) expect rates to rise for the next one year, but then decline gradually over the next several years, a floating rate product may be preferable.
The other option of going in for a fixed rate product and then switching at the end of the year will entail costs (there could be a penalty of 1-2% of the outstanding loan amount) and may not make financial sense. Moreover, floating rate home loans do not change the rate of interest every quarter (even though they may review the rate every quarter).
Menon points out "The attraction of a floating rate home loan is that it does not attract a part prepayment charge. This could appeal to individuals who get lump sum bonuses which they can use to reduce their loan exposure".
Second, the issue whether fixed rate home loans are actually 'fixed rate'. When considering a fixed rate home loan over a floating rate home loan a strong selling point is that if interest rates were to rise dramatically you will be 'protected'.
Apparently the reality is somewhat different. It seems that companies that have given out fixed rate loans can revise their rates upwards in exceptional circumstances (significant rise in interest rates for one). So if you think rates will remain range bound over the near term and decline over the long-term, you are still better off with a floating rate product.
Third, a fixed rate loan is generally priced higher as compared to a floating rate product. This holds true in the current environment where the fixed rate loan is at a higher interest rate as compared to a floating rate loan. The difference is currently about 0.25% to 1.00%.
So if you expect that interest rates are likely to move up, but only to the extent of this differential, then you should ideally be indifferent between the two types of a loan. The deciding factors then should be when you think the rates will increase, and also the long-term expectations of interest rates.
As always, there is no one answer to whether you should go in for a floating or a fixed rate home loan. If you are person with very little appetite for risk or negative surprises, opt for the fixed rate home loan. But in case you can take on some risk, a floating rate home loan is worth a look!
Five steps to picking the right loan
1. Gather data on interest rates
Get interest rate information from more than one source, and get the same information from each so you can compare the offers.
2. Get info on fees
Find out about processing fees, administration charges and other costs that may be involved in taking the home loan. A written statement of all fees from the housing finance companies will ensure that there are no surprises later on. Use the lowest amount of fees to negotiate with the other lenders.
3. Get a pre-approval letter
This gives you substantial leverage as you are then seen as a serious buyer by the seller of the property. Also, having the letter in your hand will set a limit to the amount of money you can commit to a property. This will help in identifying the right property.
4. Bargain for a lower rate of interest
Housing finance companies will reduce their 'rack' rates for customers with a good credit record. A bargain deal will easily fetch a home loan at significantly lower rates (at times you can get a discount of as high as 0.50%). Here again, get a confirmation of the rate (and for how long it will remain fixed) via a letter.
5. Watch out for predatory lending
Don't include false information on your home loan application to get quick approval. Also borrow more money than you need or can afford.
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