Home loan rates continue to soar, what should you do OR not do?
Home loans have turned expensive with the Reserve Bank of India (RBI) hiking borrowing rates 11 times in the last 16 months. The RBI appears resolute in continuing to implement such strict monetary measures to tame inflation in the future. Home loan customers are in a quandary as their equated monthly instalments (EMIs) are soaring and are further expected to make a deeper dent in their pockets. Should I switch to fixed rate loan or should I transfer the balance loan to a new bank are the common questions crisscrossing many heads. Prospective home loan seekers are wondering whether they should opt for fixed or floating rate loans. Let us address these issues one by one.
Avoid swapping floating rate to fixed rate loans: Let us assume you are at the start or middle of the loan term and have opted for a floating rate loan. Considering that interest rates will continue their northward journey as highlighted in the RBI’s policy, you are tempted to switch over to a fixed rate loan. However, it is not a very good idea. Firstly, because fixed rate home loans are around 1.5-2 per cent expensive than floating rate loans. So assume if you are paying 11 per cent interest annually on your home loan, your bank revises the rate to 11.5 per cent under the floating rate scheme. But if you switch over to fixed rate loan, it will cost you 13 per cent per annum. Additionally, you will have to pay a one-time fee which could be 1.5-2 per cent of the outstanding loan amount. Ultimately, your EMI burden is expected to be higher.
Consider balance transfer: You may want to consider prepaying the existing loan and take a new loan from another bank at a lower rate. Bargaining for a lower rate will be easier if you have a good credit score. However, the old bank will levy prepayment penalty which is usually up to 1.5-2 per cent of the outstanding amount. Customers at the start of the loan tenure will face high prepayment charges as interest component in the EMI is huge. The fresh loan will also attract a one-time processing fee and mortgage charges. However, if the amount on interest saved during the loan term is higher than prepayment charges and other transfer costs, then it is viable to make the switch. Customers in the middle of the loan tenure are relatively in a better position to switch to a new bank.
Strategy for new customers: If you can withstand disruptions in your budget due to the uncertain nature of EMIs, then it is advisable to go for floating rate loans. Presently, if you are getting a floating interest rate loan at 11.5 per cent, then fixed rate loans are being offered at around 13-13.5 per cent. So you still save money if interest rates rise by 1.5-2 per cent. Even if the floating rate increases beyond these levels, it will not be for the entire tenure of the loan as the rate cycle is likely to reverse over a longer period. So you will stand to reap the benefit of reduced rates.
On the other hand, if you are completely risk averse and cannot endure the volatility in interest rates, it is better to opt for a fixed rate loan. However, you will have to shell out a premium for the certain and secured nature of fixed loans. Moreover, fixed rate loans are not fixed in a true sense. Banks and financial institutions have a reset clause in the home loan agreement. Under this, they are entitled to raise interest rates in exceptional circumstances. Instead of hiking rates, many banks increase the loan tenure and you end up servicing debt beyond the stipulated period.
To conclude, choose a fixed or floating rate loan product based on your risk appetite. There are EMI calculators available on all bank websites. Calculate EMI discounting different interest rate scenarios and see what suits your budget. In this way your cash outflows are unlikely to go overboard and you will be able to comfortably save for other financial goals.
