Yesterday: Where is your money going?
s the home loan party over? While there are many who think so, others are not so sure. We can be certain, though, that the fun (as far as home loans are concerned) is dwindling as interest rates slowly creep northward.
Which brings us to the question uppermost on every buyer's mind: Should I opt for a flexible rate loan or a fixed rate loan?
Let's try to figure it out.
Fixed is simple
That's right. It's really simple.
You take a loan of a particular amount. The company fixes a rate of interest. You pay back the loan over the number of years that you have agreed on when you take the loan.
Since the interest rate remains fixed, your EMI -- the Equated Monthly Installment you pay back each month -- stays the same.
No surprises. No changes.
Should you go for it?
If you feel interest rates are going to rise in the future, then go for a fixed rate option. You will get the benefit of a lower interest rate if and when interest rates rise.
If changes in interest rates don't bother you and what you want is predictability, then this one is for you.
Floating sounds a little uncertain
In case you did not identify with that term, let me start by telling you it is also referred to as adjustable, variable or flexible interest rate loans.
All these terms mean the same thing -- the interest rate on your loan will go up or come down depending on how the interest rate in the economy is moving.
What this means
The home finance company will decide upon a base rate -- known as the floating reference rate. This is generally based on their internal base rate (which every finance company has) called the retail prime lending rate. The interest rate on your loan will be benchmarked against this internal base rate.
The HFC decides how often the interest rate on your loan must be changed. It could adjust the interest rate every year, every six months or every quarter. The more frequently a change is made in the interest rate, the closer it is benchmarked to interest rates in the economy.
Assume your HFC 'adjusts' the interest rate once a year at, say, the beginning of the year. Depending on whether or not the base rate has increased or decreased, your EMI -- or the tenure of your loan -- will accordingly rise or fall the next year.
How this affects you
If the base rate has dropped, the interest you pay on your loan will subsequently drop. The reverse will take place if the base rate rises.
This will result in either of the two scenarios:
~ Your EMI will fall (or rise). The tenure of your loan stays constant.
~ The tenure will decrease (or increase) while your EMI stays constant.
If you meticulously plan your monthly budget and do not want to consider a rise in your EMI, then opt for a change in the tenure. In this case, your EMI stays constant through your repayment tenure irrespective of whether there is a change in the interest rate. Your repayment tenure varies.
If you don't mind the EMI going up (everyone loves it when it goes down), but want to repay your loan in the time you decided, then opt for a fixed tenure with a flexible EMI.
Should you go for it?
If you believe that interest rates are slated to drop in the future, then you can opt for a flexible rate loan. That way, you benefit when the rates fall. But, you must also have an appetite for risk and be able to take it in your stride when rates rise.
If you decide to go with the variable tenure, check if the burden of a longer repayment period -- should interest rates rise --suits your financial planning.
If you decide to go with the fixed tenure with a variable EMI, you should be able to manage a higher EMI should interest rates rise. If you have the appetite for risk and are financially comfortable with a higher monthly payment, go for it.
Can you have your cake and eat it too?
Trust innovative financiers to come out with a hybrid variety that combines both the fixed and floating rate loan schemes.
In this scenario, assume you take a Rs 10 lakh loan that you have agreed to repay in 10 years.
One variant is to take half the loan as fixed and the other half as flexible. Rs 5 lakh will be the fixed component on which you pay a fixed EMI and Rs 5 lakh will be the variable component on which your EMI will vary according to the rise and fall in interest rates.
The other variant is when the entire amount of Rs 10 lakh is taken as a fixed rate loan for some time, say three years. As for the balance amount of time (seven years), it turns to a variable interest rate loan.
Should you go for it?
If you want some amount of stability but are also willing to take a risk, opt for the part fixed and part flexible option.
If you are sure interest rates are going to fall after some years, take the fixed option for a few years and the flexible option later.
What's happening now
When interest rates were really low a few months ago, it would have been wise for home loan takers to take a fixed loan option and lock in their money at a cheap rate. Instead, many of them opted for floating rates.
ICICI Bank says a majority of its home applicants are opting for floating rate loans even today.
HDFC gave some interesting statistics. While 90 percent of its home loan takers were opting for a floating rate loan 18 months ago, that figure has dropped to 70 percent today.
As of now, almost everyone is unanimous about the fact that interest rates are slated to rise in the near future. A long-term view is not really possible.
The difference of opinion generally rests with the timing of the rise. While some say an immediate rise is imminent, others say one could expect a slight rise next year.
For those thinking of going in for a flexible rate loan, chances are slim that rates will rise to astronomical levels. If you would rather not take the chance, though, lock in your loan cost now at a lower rate.
If your loan is for a long tenure -- say 10 years or more -- then a flexible loan option may be a better bet since, over time, interest rates could fall. If your loan is for just a few years, it may be wiser to lock in at current rates.
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Image: Dominic Xavier
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