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There is a difficult option to choosing a home loan. Selecting a bank, arriving at the tenure, etc, are not easy decisions. A home loan contract is spread over a long term with many implications for a borrower, hence one need to be careful while getting into such a contract.
Tenure: You need to decide whether you should go in for a long-term loan, a short-term loan, or a medium-term loan.
A long-tenure loan binds you for a longer period of time. The good news is that you can terminate it early without paying any prepayment penalty.
A short-tenure loan is advisable during times of high home loan interest rates. Here, the equated monthly installments (EMIs) are higher and can affect the cash flows of the borrower. In case you are looking at a longer tenure, opting for a floating-rate product makes sense as these high-interest rates won’t be sustainable in the long term. A lot will depend on the cash flows of the borrower. In case of high interest rates, you should opt for a shorter duration loan. So, the net interest outflow is lesser. The principal outflow component in the EMI will be more. But then the EMI amount increases in absolute terms in this case.
Scheme: Now, we come to the question of an option: fixed or floating. Under a fixed rate of interest, the rate of interest is decided before hand, at the time of taking the loan. The rate remains the same for a certain number of years. Nowadays, there is nothing called a pure fixed rate product.
However, considering that the interest rates are already at a peak and a downward trend has started, which is expected to improve further in the coming months, it does not make sense to lock into a fixed rate loan now.
In case of a floating-rate loan, the rate of interest is linked to the market rate or a benchmark rate. The rate of interest varies directly with the market rates of interest. In case the interest rates go down, the cost of borrowing for the borrower also goes down. In case the rates of interest go up, the cost of borrowing for the borrower also goes up.
Thus, the borrower floats along with the market rates of interest and has to constantly monitor the market movements.
As the home loan interest rates are expected to drop in the coming months, opting for a floating rate loan makes more sense. The signals from the Reserve Bank of India (RBI) and bankers in general are that the measures taken earlier are working now and the inflation rate is under control. This has also been indicated in the credit policy statements issued recently by the RBI. The interest rates are not expected to increase now. One may expect the interest rates to actually cool down. In order to take advantage of this, a borrower should go for a floating-rate option now.
Hybrid options: There are a few variants of floating interest rates available in the market, where the interest rate remains fixed for a certain period and then the scheme is converted to a floating rate. Again, in the present scenario, these products may not be suitable. They are better in conditions where the interest rates are expected to increase.
Nowadays, you have the option of switching from one lender to another, after paying a small fee. This makes sense, especially in case the difference between the interest rates is high. Also, the sweetener of no prepayment charges should be used.
This option will make sense if the remaining tenure of the loan is long. You need to make a cost-benefit analysis to arrive at a decision.