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2/05/2007

Home Loans



With interest rates on home loans heading north, the retail investors may benefit by going in for fixed rate loan for all long during loans like housing loans. The interest rate charged on housing loans tends to vary with a benchmark rate, which is generally the prime lending rate.

To check inflation and avoid formation of the so called 'asset bubble' the Reserve Bank of India (RBI) has proactively raised the cost of borrowing for banks by raising the cash reserve ratio (CRR) and repo rates. The prime lending rate (PLR) of the major banks, which was in the range of 10-11 per cent earlier, has increased to 11-11 .5 per cent. The fallout of this action is the increase in the lending rates for housing loans by all the banks.



We were having a soft interest rate regime in the last few years making floating rate loans very attractive. The interest rates which hit rock bottom in 2003 was revised upwards by 50 basis points each in 2004 and 2005. However , in 2006, it was revised upwards three times amounting to a total increase of 150 basis points, the recent one being 50 points in December 2006. This brings the retail investors to the tricky question - whether to go in for a floating rate scheme or lock into a fixed rate.


The answer to this question lies in interest rate movements.

You are exposed to interest rate risk in the case of a floating rate loan scheme. When the interest rate falls, the EMI is also likely to fall, or the tenure may be reduced. This works in the investor's favour. But if the PLR moves up, the interest rate on your loan would move up, leading to unplanned increase in outflows in the form of additional EMIs

A floating rate scheme is best-suited in a falling rate scenario. But it becomes expensive when the rates move up. The good thing about a fixed rate scheme is that the interest rate charged remains fixed throughout the term of the loan. The recent increase has not impacted the fixed rate borrowers whose EMIs and tenures continue unchanged . Which means that the borrower is immune to fluctuations in interest rates

Almost 90 per cent of the existing housing loans in India are said to be under floating rate schemes. Banks too tend to push floating rate loans as it protects them from negative impact of rising interest rates. This may not be beneficial from a borrower's point of view as any upward movement in interest rates will increase EMIs or your loan tenure, i.e., the number of EMIs that one has to pay.

Most banks offer floating rate loans at an interest rate that is slightly lower than that of fixed rate loans. Typically, for fixed rate loans, most banks charge a higher rate of 25 to 50 basis points over floating rates. Even then, experts prefer a fixed rate loan rather than a floating rate one as it spares you the headache of tracking changes in interest rates or worrying about your additional EMIs.


It is advisable to go in for a fixed rate scheme if one feels that the rate of interest in the market has touched rock bottom and hence they may go up. With India being in the trajectory of high growth, inflationary pressures will continue to build up in the economy causing interest rates to either remain steady or rise. Therefore, choosing a fixed rate housing loan would be the most sensible option for borrowers in the current scenario.

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