In the bad old times not so long ago, only rich old families owned homes. Salaries were low and loans expensive, costing upwards of 15 per cent per annum. In the early part of this decade, home loan rates dropped sharply, and by 2003, you could get a home loan for as little as 7.75 per cent per annum (floating). Meanwhile, real estate prices had been depressed for five years.

Home buyers' ecstasy . . . Rising income levels and the boom in the information technology and related services sector made it possible for many families to buy homes.

"Sustained growth in the economy coupled with easy availability of home loans led to a huge demand for quality residential projects," says Maj. Gen. (retd) Jayant Varma, executive director (north), Knight Frank (India).

Younger and younger people began putting down money to buy homes, signing attractive home-loan agreements to fund the bulk of their investments. For the next couple of years, things looked great - salaries continued to rise, making EMI payments a breeze.

Another development was that real estate prices zoomed, so even if the paint in your building lobby was peeling, you felt wealthier every time you saw a flat like yours listed in the real estate section of a newspaper or magazine.

. . . and then, agony. But, beginning 2005, interest rates started creeping up. Many who had opted for floating rates kicked themselves for not locking into fixed rates while they were low.

Rohan Kanchan, 29, a Mumbai-based communications professional, is one of them. He opted for a floater in 2002, when the interest regime was on its way down. Now that the tide has turned, the time he will take to pay back his loan (the so-called tenure) without changing his EMI has increased from 15 years to 20.

Atul Verma, 31, a Delhi-based software engineer, feels aggrieved for another reason. He wanted a fixed rate housing loan, but was pushed into a floating rate loan. When interest rates floated up, he had the option of either increasing his loan tenure or pay larger EMIs. He chose the latter since he didn't want to stretch his 20-year loan tenure.

Meanwhile, of course, the cost of housing has hit the high road. In most urban centres, real estate prices have climbed two- to three-fold between 2003 and now. The combination of rising prices and hardening interest rates has reduced the enthusiasm of would-be buyers.

Inflationary home economics

In 2004, if you were planning to buy a two-bedroom flat in the suburbs of Delhi, it would have cost you around Rs 20 lakh (Rs 2 million). At that time, a 15-year loan would have come at 7.50 per cent. If a down payment of 15 per cent came from your own resources, so that you took a loan of Rs 17 lakh (Rs 1.7 million) to buy the flat, your EMI would have worked out to around Rs 15,759.

Today, the same property would cost you over Rs 40 lakh (Rs 4 million), and a 15-year home loan attracts an interest rate of 9.50 per cent. So, if you were to borrow Rs 34 lakh {Rs 3.4 million (again funding the 15 per cent down payment yourself)} for 15 years at 9.50 per cent, your EMI will work out to around Rs 35,503. This is just the cost of the house, other costs like registration will set you back by a few extra lakhs.

Are Things Going to Change Radically?

Real estate prices. Experts believe that select areas in metros are seeing a reduction in prices. "Delhi, Mumbai and Bangalore are indisputably seeing areas of correction. Property prices in Kolkata and Chennai might see a slowdown in the growth rate soon," says Anuj Puri, MD, TrammellCrowMeghraj.

In Mumbai, prices of residential units in Andheri and Goregaon are 20 per cent below their peak levels. There has also been a correction in Navi Mumbai and other suburbs. In some parts of the Delhi NCR region, prices have sunk by 15-20 per cent. In parts of Bangalore, residential property prices have gone down by 10 to 20 per cent.

However, the correction is not likely to be either sharp or deep - international experience shows us that most rallies in residential property end in a soft landing rather than abrupt drops.

Also, asset prices, including prices of residential units, tend to move in cycles. In India, this cycle has tended to move up for six to eight years before softening for another six to eight years. This particular uptrend is only four years old, so those betting on downward moves in housing may yet see higher prices in certain areas.

Home loan rates. As regards interest rates, they have firmed considerably in the last two years. From a low of 7.50 per cent in 2004, the rate of interest on a 15-year loan had climbed to 8.25 per cent by January 2006. This has now gone up to 9.50 per cent. What lies ahead?

"It is very difficult to predict interest rate movements. Though liquidity is strong now, it would be important to track factors such as inflation, growth rate and money supply to know the trend," says Rajiv Sabharwal, head, retail assets, ICICI Bank [Get Quote]. Sameer Kaul, business manager, mortgages, Citibank, believes that "interest rates may continue to have a slight upward bias; however, it is difficult to predict how much higher they can go from here". At the same time, few think that we are likely to see interest rates at the historic heights of the 1990s.

Home buyers' emotion. The way we look at it, trying to second-guess the markets, whether in real estate prices or in interest rates, is a difficult proposition. While the speculator profits or loses directly with the rise or fall in real estate value, for home buyers, the special feeling of owning a house is more important than these notional gains.

Take the case of Neeru Kumari, 27, a Bangalore-based Chinese language specialist. Neeru lived in a rented flat in Bangalore. She calculated that renting was a lot cheaper than buying. Yet, she decided a month back to take the plunge and book her own flat. She made it easier for herself by taking a step-up loan, where her EMI will be Rs 17,000 for the first two years, before settling down at Rs 20,000.

But for her, the decision is partly an emotional one, and she is not too fazed by the prospect of an increase in interest rates. "After all, all this hardship that you are taking is for your own house," she says.

Why You Should Buy Even Now

Given the current situation of high real estate prices and loan rates, does home buying have to be purely driven by emotions or is there an adequate financial logic for purchasing your own home? The good news is that even in this scenario, there exist five compelling reasons why you should buy your dream home.

1. Advantage from tax breaks and inflation

Tax breaks for home loans and inflation's impact on home loan repayments are two factors that continue to work as loyal servants for the home buyer. Under the present tax rules, you can get a tax break on interest repayments for home loans to the extent of Rs 150,000 and on principal payments up to Rs 100,000 per annum.

And, as inflation raises all other costs (and incomes), the real cost of your EMI becomes easier to bear. If you look at a loan of Rs 30 lakh (Rs 3 million) with a tenure of 15 years carrying a 9.50 per cent interest rate, the EMI works out to Rs 31,326, or roughly Rs 375,000 per annum.

After accounting for the income tax deductions thereon, the real cost to your cash flow for the first year would be only Rs 256,000.

Assuming that interest rates remain the same, by the end of your loan period, the 'real' cost of this EMI, after adjusting inflation and deducting tax, will be only Rs 72,428. This is probably the only time you will bless the bites that rising prices take out of money - it works to make your EMI cheaper each year.

2. Rising salaries

Meanwhile, salaries will continue to rise, both in nominal and real terms. According to a recent survey, the wages of mid-level IT professionals in India have risen by an annual average of 23 per cent in the last four years.

For other sectors too, be it new economy ones such as telecom or old economy ones such as FMCG, the salary growth rates have been in double digits. Thanks to these hikes, the average cost of a home has dipped from 11 times the home loan borrower's income in 1997 to 4.6 times now.

Estimates vary, but forecasts indicate that the salary growth is slated to remain in double digits for at least the next two to three years. With corporations increasingly including performance-linked pay in compensation packages besides wealth-creating pay components such as employee stock options, the effective impact of pay hikes will be much more.

Last, but not the least, even if our current economic boom slows into steady growth, our continued integration into the world economy will mean higher salaries for managerial, scientific and skilled talent.

The net impact of the sustained pay hikes will be that even as the inflation-adjusted impact of the EMI will decline over the loan tenure, the percentage of the take-home salary going out as home loan repayment will keep decreasing, easing the burden on the borrower even further.

3. Longer working lives

Your parents may have retired at 58 or 60, but you are unlikely to hang your boots so soon. Increased lifespans and better healthcare facilities will help you have a much longer professional life than your parents. This means that you will get a much longer period to repay the home loan. This is especially helpful if the tenure of your floating rate loan gets extended.

As the Indian economy grows, an acute talent shortage - signs of which are already beginning to surface - will make it financially tempting for skilled individuals to move on to a second, third and, perhaps, even a fourth career.

This is something that is already happening in the West, especially in the US, where people are increasingly looking at working till age 70. Thus, even if someone is taking a loan at 31 today, it is unlikely to stretch him financially since he will be 51 at the end of a 20-year tenure.

4. Appreciation of property values

As an investment, homes will continue to be as rewarding as in the past. Even if housing prices tumble over the next few years, they will more than recover - this has been their history in modern India.

Urbanisation is bound to accompany our economic progress - 30 per cent Indians will be living in cities by 2010, a figure that will go up to 40 per cent by 2020. Experts expect this to create a long-term housing shortage.

In the next 10-15 years, it is estimated that 85 million housing units will have to built to meet the demand for homes. That's a tall order. Thus, it is reasonable to conclude that the possibility of a few years of drop in housing prices will be dwarfed by the virtual certainty of housing values going up manifold over the lifetime of a typical home buyer.

Some experts are quoting an annual return of 12-15 per cent over the next six to seven years despite short-term dips. If these forecasts materialise, not many would be complaining.

5. Reverse mortgage

The great thing about owning your own home is that if you need the money in the future, you can always unlock its value - even without moving out. With reverse mortgages coming to India, your home can become a financial planning tool for your old age, especially if you have paid fully for it by then.

What is a reverse mortgage? In a conventional mortgage, with every EMI that you pay, your equity in the house increases. Once you have paid up the entire loan to the housing finance company, your equity in the house will be 100 per cent.

In a reverse mortgage you do the opposite. You pledge your house with a financing institution that pays you a monthly amount based on factors like your age, value of your house and so on. Proposals for implementing reverse mortgage in India are being prepared by the National Housing Bank.

In fact, Dewan Housing Finance Corporation [Get Quote] is already in the market with India's first reverse mortgage product.

Clearly, there is no change in the home truth: the time to buy your first house is always NOW. Provided you can afford it both in terms of the down payment and the home loan.

In the affordability equation, choosing the right home loan holds the key, more so in the present circumstances.

For most, it is easier said than done, given the inadequate information people have on the way interest rates are determined and charged. Regrettably, much of the information is in the fine print of home loan agreements that few care to read. To empower you, we provide you with a primer on home loan rates and then arm you with an action plan.

Home Loan Rates Demystified

In order to lend you money, banks and housing finance companies borrow from depositors like you and from corporate and government institutional lenders. Obviously, they need to charge you a rate higher than what they pay out. The difference between the cost of their borrowing (also referred to as their cost of funds) and the cost of your borrowing, or home loan rate, is their 'spread'. The higher the spread, the greater their profits.

Floating rate loans. In the case of floating rate home loans, the bank or HFC determines the rate you pay with reference to some benchmark, referred to by different banks as 'prime lending rate' (PLR), 'advance rate', or 'mortgage rate' (see: Owning the Keys to the Treasury).
 

Owning the Keys to the Treasury
Banks	Benchmark	Fixed by	Current benchmark rate (%)	Current floating rate (%)1
Citibank	Citibank Mortgage Prime Rate	Bank	11.5	9.5
HDFC [Get Quote]	Retail PLR	Bank	12.25	RPLR minus 2.75
ICICI Bank	Floating Reference Rate	Bank	10.25	9.5
SBI [Get Quote]	State Bank Advance Rate	Bank	11	SBAR minus 1.25-2.25
Bank of Baroda [Get Quote]	BoB Prime Lending Rate	Bank	11.5	BPLR minus 1.25-2.25
HSBC	Prime Lending Rate	Bank	11.5	9.5
ABN Amro Bank	Mortgage Floating Reference Rate	Bank	11.5	9.5
Kotak Bank	Prime Lending Rate	Bank	12.25	9.25
ING Vysya Bank [Get Quote]	Home PLR	Bank	13.5	9.5
1As applicable to new borrowers
PLR: Prime Lending Rate
In all the above cases, the floating rate is revised every three months from the date of first disbursement and it matches the revision in benchmark rate; the benchmark rate is reviewed every quarter (exact date not specified by a majority of banks) and it is at the discretion of banks to revise it or not

Your floating loan carries a rate that is usually upto 3 per cent lower than this benchmark. But that does not mean you are being obliged - this benchmark rate is not the cost of funds for the bank or HFC. It is an internal measure related to the cost of funds.

Nor is there any legal sanctity to the difference between the benchmark and the floating rate. For instance, on 1 July 2006, Standard Chartered Bank had a current home loan reference rate of 12.50 per cent and stated that the floating loan interest will be upto 5 per cent below this. On 31 August, this was 9.85 per cent.

If the cost of funds goes up, banks and HFCs tend to maintain their spread by increasing their benchmark rates and hence your floating loan rates. But the two do not necessarily rise at the same pace or time.

Says Sujon Sinha, head, retail assets, UTI Bank [Get Quote], "When interest rates are falling, a bank lowers the prime lending rate only after the cost of funds falls by 0.50 to 0.75 per cent. But if the rates are climbing up, a bank is prompted to raise the rate for every 0.25 per cent rise in the cost of funds."

Obviously, you do not benefit by this arrangement. Says Harsh Roongta, CEO, apnaloan.com: "Lending rate affects only loans. A far more objective benchmark reference rate would be one that affects a much larger body of parties - for instance, fixed deposit rates, since they also represent the cost of funds for a bank or HFC."

Banks and HFCs even differentiate between existing floating rate customers and new ones. For example, as ICICI Bank reduced its internal retail PLR from 11.50 per cent in 2002 to 9.75 per cent in early 2004, its existing floating rate borrowers saw their loan rates drop by two per cent, but new borrowers received a further one per cent benefit.

Says Sreenivasalu Raju, loan manager at Andhra Bank [Get Quote]: "The problem of non-transparent rates is felt by a customer only when the rates fall. A customer does not have an accurate idea of the fall in rates."

The case of Kamal Baldi, 43, illustrates what can happen when a bank follows an internal benchmark. When he signed up for a Citibank home loan in April 2005, it was at 7.25 per cent.

The bank uses an internal benchmark rate, mortgage PLR, and when it revised it upwards, his interest rate moved up to 7.75 per cent without any intimation. In April this year, his loan rate was further revised to 8.25 per cent, though he was informed this time around.
 

The Foreign Factor
Country	Benchmark	Fixed by
USA	Internal PLRs	Banks
	Treasury indexed rates	Independent
	Cost of funds indexed rates	Independent
	Libor-based rates	Independent
UK	Libor	Independent
	Internal PLRs	Banks
Australia	AAPR1	Banks, but disclosed in ads
China	Composite rate	Monetary authority suggests, but banks are free to use internal rates
1Annualised Average Percentage Rate

Says Baldi: "We will be more comfortable if the bank shares with us how exactly it calculates its mortgage PLR." But banks and HFCs rarely oblige. Neither has the RBI shown any inclination to make the calculation and implementation of internal benchmark rates by banks more transparent.

Your action plan

Examine your home loan agreement. If your bank uses an internal benchmark rate, you need to be alert. Start by getting a copy of the home loan agreement. If the bank does not provide you with one, insist on it - it is your legal right. If necessary, lodge a complaint with the RBI.

Keep a tab on the interest rate. You need to track the changes in the interest rate on your loan. Says Ian Hamilton, analyst with Australian consumer infomediary Infochoice:

"Don't sit and forget your loans and accounts; review them regularly and shop around, comparing widely. Don't be afraid to vote with your feet and move elsewhere. But more often than not, you may win by going back to your lender and demanding a better deal."

Fend off agent's hardsell. Don't sign a home loan agreement without spending a few days looking over it. Take your time, and don't feel pressured by your home loan agent -for most of us, our homes are the largest single investment we will make. Above all, remember that the banks need us as much as we need them.

The financial logic in favour of buying a home continues to be compelling. But to exploit the multiple advantages to the hilt, the home buyer has to be on his guard while taking the loan. That's the important caveat to the unchanged home truth.

Part II: Why floating home loan rates always rise

With Vishal Chopra in Delhi