Rates hold key to home loans

If you have borrowed from a bank to fund your dream home, the recent increases in interest rates may have a big bearing on your finances. Many banks, including SBI, ICICI Bank and HDFC Bank, have already increased their floating home loan interest rates.

The recent increase in CRR and repo rates by the RBI has prompted banks to review their own lending rates. The banks had kept their home loans rates unchanged, despite a steady increase in CRR and repo rates, over the last one year. But with funds getting costlier, banks now have no choice but to increase the home loan rates. There is also a difference in the way banks have changed their “fixed” and floating rate loans. SBI has not increased its interest rates on fixed rates home loans, whereas ICICI Bank and HDFC Bank have raised fixed rates to 14.75 per cent and 14 per cent, respectively.

SBI has also increased the processing fees on all loans. An increase in home loan interest rates, whether fixed or floating, would mean a higher monthly instalment or a longer tenure on your existing home loan.

With a half per cent increase in the home loan rates, the home loan customer may have to pay anywhere between Rs 25 and Rs 35 per month extra on every Rs 1 lakh they have borrowed. Purchasing a house can be a costly affair with rising property prices, increase in raw material costs, and higher interest rates.

Fixed and floating rate

Borrowers looking to respond to rising interest rates first need to evaluate if they have contracted a fixed rate or a floating rate loan.

Floating rates are pegged to the benchmark prime lending rate of the bank which is, in turn, reset from time to time, taking into account the market scenario. Therefore any increase or decrease in the market rates may have impact on the floating rate. Floating rate can be advantageous in a declining interest regime. However, if you are going in for a 20-year housing loan, you may see both rising and falling interest rates.

The fixed rate loans, as the name suggests, are fixed in nature and are insulated against any interest rate changes. But check whether the fixed rate loan you have has a reset clause. A ‘reset’ clause allows your bank to review interest rates periodically, often once in two years. Therefore, if interest rates continue to rise after two years, fixed interest rates may also be increased.

Fixed rates, though they offer predictability, are an expensive option as they are usually at a premium to the floating rate loan. For instance, for SBI, the interest rate on a five-year loan for less than Rs 30 lakh is 10.5 per cent, but the fixed rate for the same loan stands at 12.75 per cent. It costs an additional Rs 113 per lakh to go for fixed rates over floating for the above loan. Therefore the borrower has to decide between fixed and floating rate keeping in view not only the current scenario but also the future movement of interest rates.

Options for borrowers

Banks offer various options to existing customers such as extending the tenure of the loans (rather than increasing EMI) or prepayment of part of the loan. For a 20-year Rs 20 lakh loan taken at SBI, a half per cent increase in home loan rates will lead to eight-nine months’ extension to the loan’s tenure, if a borrower does not want to opt for a higher EMI. However, extending tenure is not possible if the borrower is nearing retirement.

It is true that affordability is hit by the increase in home loan rates and other factors, but new borrowers need not defer their plans of buying a house on this score.

Home loan customers need not panic as interest rates will come down as and when inflation moderates and the RBI starts cutting interest rates. New borrowers can also evaluate structured products such as part fixed-part float interest rates, step-up EMIs, which are low in the initial stages but increase in later years. Borrowers also have the option to switch to fixed interest rates for a fee.