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Home loan: Fix your interest rate now!

Shobhana Subramanian | July 13, 2004 11:44 IST

Inflation hit the six per cent mark last week. Economic theory tells us that interest rates and inflation move hand in hand. There are also other tell-tale signs overseas, not to mention weighty pronouncements from those in the know, which hint that Indian interest rates would probably go up sooner than later.

This means that borrowers who have home loans and have plumped for a floating rate option -- where the interest rate rises or falls in relation to the prime lending rate of a bank -- are probably in for changes in their repayment schedule.

More likely than not, there would be an increase in the tenor of loan (or an increase in the equated monthly instalment (EMI), which many banks don't prefer since it means re-writing post-dated cheques).

In the last two years, with interest rates going down by over 300 basis points, bank statements brought joy because the home loan rate would have been revised downwards and tenors reduced a couple of times.

But now, it's probably time to rethink your options vis-a-vis the floating rate--and also check out the alternatives.

The reason why you would need to have a chat with your banker, especially if you have tied up the loan in the last two years, is this: If the interest rate moves up by 100 basis points (or one per centage point), the tenor increases by 2 years -- if the existing tenor is 15 years. That works out to a 14 per cent increase in tenor.

If interest rates move up by 200 basis points, then the tenor could go up by as much five years, or 33 per cent.

That should set you thinking.

Now let's take EMI per lakh instead of tenor, and use the loan example above.

For a 100 basis points rise in interest rate, the EMI rises from Rs 928 to Rs 985 -- or about six per cent. And if the rate rises by 200 basis points, the EMI goes up to Rs 1,045, or 12.5 per cent.

For an average loan size of Rs 6 lakh, this means your EMI will go up from Rs 5,568 to Rs 5,910 in the first case and from Rs 5,568 to Rs 6,270 in the second. That could pinch.

Industry statistics say 95 per cent of loanees appear have opted for a floating rate product and that too in the last two years. And the average tenor of these loans is 13.5 years. The imminent changes thus affect a majority of the loanees.

So, make it a point to meet your lending bank to check whether or not you have the option of shifting from a floating to a fixed loan and what the cost would be.

ICICI Bank, according to Rajiv Sabharwal, general manager, will allow customers to swap their loans from a floating to a fixed rate.

At HDFC, however, such a facility does not exist. That would certainly cause some sleepless nights, but Suresh Menon, general manager, Mumbai region, HDFC, assures that HDFC will be coming up with such a product as and when the need arises.

Certainly, the fixed rate that you will be locking into will be higher than the floating rate that you are paying right now. However, your downside will remain protected for the rest of your tenor.

As of now, no bank has raised rates. However, it would be pertinent to remember that when the floating rates rise, the fixed rates actually move up more.

For instance, if the floating rate increases by 100 basis points, the fixed rate, could move up by as much as 150 basis points, which is understandable since bankers need to cushion themselves for the long term.

The trick is in not waiting for the floating rate to be reset upwards, because by then the fixed rate too will have moved up. So it may turn out to be wise if you are getting a fixed option today somewhere in the region of 7.75 to 8 per cent.

But there is a fee attached to converting the loan. A figure that is being talked about is 1.75 per cent of the outstanding loan amount. That may seem a trifle intimidating at first, but it's not that bad actually.

For example, if you have a balance loan of Rs 5 lakh, it works out to about Rs 8,750, which is less than two EMIs. That may be well worth the money.

The bank may try to persuade you to stick with the floating rate product by saying that the EMI is not going to change, only the tenor is.

In other words, even if rates continue to rise, you can cap your monthly outflows and continue to pay the loan for a longer time. However, that still means that you are going to cough up a larger sum.

Sure, over a longer period of ten years or so, rates could move down again. However, even experts have gone wrong in predicting interest rate movements and in these uncertain times where global markets are integrated, it would probably be a better idea to protect your downside, and ensure that you sleep peacefully at night, rather than worry about what might happen in the future.

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