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What to do about home loans now
Sucheta Dalal, MoneyLife | May 10, 2007
The five-year borrowing frenzy - when home loan rates at under 7 per cent were at their lowest ever - has decisively ended. It is now trauma time. After seven interest rate hikes in less than two years (a 4 per cent increase), middle class borrowers are realising the full horror of floating rate loans and desperately seeking ways to reduce the pain.
In some cases, especially for those who have borrowed two years ago, the loan tenures have almost doubled - but only for younger borrowers. Others have seen equated monthly installments rising much faster than salary increments and many are being nudged by lenders to partly pre-pay their loans.
This is the time to be careful; don't compound the problem by making wrong decisions without carefully weighing the options. Many borrowers are tempted to switch to fixed-rate loans, but it is very important to look before you leap.
The first thing to do is to calmly decide whether interest rates are headed further up or have they almost peaked. Top bankers tell me that we have already reached a high level of pain and an even a 50 basis point (0.5 per cent) increase will have serious consequences.
After all, floating rates, which were 6.75 per cent in 2004-05, have risen over 3 per cent in the last year alone and are now in the region of 12 per cent (upto 14 per cent on fixed-rate loans).
Your options in this situation depend on factors such as age, financial situation, annual salary increments, implication for tax benefits and, most importantly, the year when the loan was taken.
The worst-hit are those who borrowed just two years ago. They came in at around 7 per cent; their interest is already up by 4 per cent. The repayment tenure would double for these borrowers and they would do well to find the money to reduce their borrowing through a part pre-payment.
The impact of higher interest varies according to the date of borrowing. Those who opted for floating rates several years ago, benefited from falling interest rates and the subsequent rise, has only recently begun to hurt. They may still be able to ride out this phase without doing anything.
The worst thing to do at this time is to switch to a fixed-rate loan.
Making the switch would involve a fee and it would be a double whammy if interest rates begin to drop after six months. Those who availed of three-year and five-year tenure for fixed-rate loans have little choice but to pay higher interest if the tenure has ended.
But even "pure" fixed-rate loans, which are expected to remain constant throughout the loan tenure, often have a sneaky 'reset' clause hidden in the agreement.
On questioning, finance companies assured borrowers that it would be invoked only in extreme circumstances. With former Reserve Bank of India governor, C Rangarajan, warning that interest rates could rise a tad further, banks may want to invoke the reset clause.
Personally, I believe this one-sided clause can be challenged in court, but it is expensive and tedious. After all, banks have collected higher interest on fixed-rate loans earlier.
The growth in home loan financing has already halved to around 15 per cent p.a but new borrowers would do well to remember not to keep the EMI so high that your paycheck sends you into depression.
Allow some leeway for contingencies or an occasional splurge, without another personal loan or expensive credit card borrowing. If you have extra money saved up or left over, you can always make a part pre-payment.
Financial advisors would occasionally advise against pre-payment in order to take full advantage of the tax benefits on home loans and that may be right for some people.
But individual temperament dictates one's comfort level with outstanding loans and you alone must decide what is best for you.