Fixed rate loans, once a favorite with risk-averse home loan seekers, could make a comeback in the near future. The fixed versus floating debate, which was considered settled in favor of the latter, may be revived if an RBI committee’s recommendations on providing impetus to fixed rate loans are accepted.
For many years now, floating rate loans have surged ahead of their fixed rate counterparts on the popularity charts, thanks to the substantial differential in rates.
In fact, until lenders like Axis Bank BSE -0.74 % and HDFC BSE -0.14 % introduced long-term fixed loans last year, this category had been sidelined. Now, the RBI committee has made out a case for encouraging fixed rate home loans — relaxation in pre-payment penalty and reduction in differential between floating and fixed rates.
The committee report has advised banks to charge pre-payment penalty only on the outstanding loan amount. This apart, the banking regulator’s report also suggests that banks offer longer-tenure fixed-rate loans of up to 30 years in order to reduce the EMI (equated monthly installment) amounts. Banks should also consider offering fixed rate loans with a reset once in 7-10 years, the report said.
“The recommendations are really a welcome move for all those who can start with a small EMI, taking into account the high inflation levels and affordability of a home loan burden,” says VN Kulkarni, chief counselor with the Bank of India-backed Abhay Credit Counselling Center.
Now, some borrowers are averse to floating rate loans, discouraged by the experiences of their acquaintances who are paying a high rate after the initial soft period. In addition, the chief grouse is that banks rarely pass on the benefits of lowering interest rates in the system to existing borrowers.
If the committee’s recommendations are implemented by the banks, such loan seekers could find fixed-rate loans worthwhile.
“Longer-tenure fixed rate loans will surely benefit consumers when interest rates are rising. Fixed rate loans will shield borrowers from volatile fluctuations in interest rates. If we look back, borrowers who had taken loans at 8 per cent in the year 2007 are now paying close to 14 per cent on their floating rates — which surely also lengthens their loan tenor if EMIs have not been increased.
Hence, there are certain advantages for fixed rate loans,” says Rajiv Raj, founder of credit counseling firm Credit Vidya.
They will always hold some appeal for certain category of borrowers. “Fixed rates will provide comfort to those with tight budgets, as they can plan their expense allocations better. There will not be any uncertainty while planning expenses at least on this count. Many, in fact, faced difficulties when they had availed home loan at 8 per cent floating and subsequently the rates shot up, touching a high of 12-13 per cent. Their budgets went out of control, forcing them to borrow at a higher rate to meet their demands,” adds Kulkarni.
So, if you want to go for fixed rate loans now, you need to compare the rates offered by various banks and take into account special fixed rate schemes offered by a couple of lenders. For instance, such loans could charge an interest rate lower than their regular fixed rate offers. These rates could be reset after a longer period of time, say 10 years.
“What the borrowers need to understand is the interest rate scenario as they approach this reset clause. That is when they have to decide between shifting to floating rate or continuing with fixed rates,” says Kulkarni.
However, as mentioned earlier, the huge difference — 100-300 basis points — between fixed and floating rates continues to be the stumbling block for fixed rate loans. Also, in the current scenario — where interest rates are heading south — opting for a fixed loan may not be a good idea. “Fixed rate loans are best suited when the interest rates are bound to go up, or rise. It would be a costly affair if you lock yourself into fixed rate when the interest rates are falling.
You will be stuck with the fixed rate and can’t take advantages of low interest rates. In the long-run, floating rate loans will look cheaper, if interest rates remain soft,” says Raj.
Then, of course, they come with pre-payment penalties, especially if you are refinancing the loan through another lender. In contrast, in case of floating rate loans, you will not have to pay prepayment penalties, irrespective of whether you are repaying the loan out of your own funds or through balance transfer to another bank.