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It's tough to take a decision on interest rates for borrowers, especially with long-term loans. Suppose your age is 40 years and you've taken a floating-rate home loan for 20 years. If you do not prepay and end the loan well in advance, you are sure to go through periods when interest rates will rise and fall several times during the 20-year period.
The worst case scenario is when rates go up sharply, forcing you to increase the loan tenure. If the bank is unwilling to lend beyond the age of 60, the equated monthly instalment (EMI) will increase proportionately. Not a situation to be in and one of the few where a fixed-rate home loan product might work in your favour. Experts say fixed home loans usually make sense in a rising interest rate scenario or when these are low and expected to rise.
The product might also work for lesser-sized ones, for customers borrowing less than Rs 50 lakh, are sensitive to interest rate increases and averse to small increases in their EMI outgo. "This product might be suitable for those who are ultra risk-averse and can't live with uncertainty. These investors are happy to lock in a particular rate and don't care if interest rates move down," said Harsh Roongta, director, ApnaPaisa.com.
Axis Bank seems keen on tapping this section of borrowers. The private sector lender recently introduced a fixed home loan scheme for a tenure of 20 years, at an interest rate of 10.4 per cent, for a loan size up to Rs 50 lakh.
However, with interest rates expected to fall sharply in the coming months, not many customers or experts favour the product. Also, unlike Axis Bank, most fixed home loan products are for much shorter tenure and are reset to floating rates after three, five or 10 years, further reducing the potential for any gain.
"Floating rates make more sense at present, as interest rates are expected to come down in the coming months and fall further over the next two to three years," said Arnav Pandya, a certified financial planner. Gaurav Gupta, founder and CEO of MyLoanCare.in, seconds this. "Fixed home loans have not seen significant interest at this point in time as rates have peaked and customers are reluctant to lock in at these rates," he says.
Let's take an example to see how the two modes impact interest outgo. Assume interest rates remain constant and an investor opts for a 20-year floating-rate loan of Rs 40 lakh from ICICI Bank at 10.1 per cent. In this case, his total interest outgo will be Rs 53.28 lakh. If, instead, he'd opted for a fixed-rate loan at an interest rate of 10.2 per cent from the bank, his interest outgo would have risen by Rs 63,872 to Rs 53.92 lakh. Now, assume interest rates go down by an average of 50 basis points (bps) during the loan tenure. The interest outgo for a floating loan works out to Rs 44.55 lakh. So, he has to pay an additional Rs 9.36 lakh by way of interest if he takes the fixed loan option. On the other hand, if rates were to go up by an average of 50 bps during the tenure, the fixed-rate borrower will benefit, saving Rs 12.05 lakh in interest outgo.
Issues with fixed rates
There are two obvious disadvantages with a fixed home loan product. One, they are typically 10-40 basis points (bps) pricier than adjustable home loan rates. For instance, Axis Bank charges a floating rate of 10.15 per cent for loans up to Rs 75 lakh or 25 bps lower than the 10.4 per cent charged for fixed home loans.
Two, unlike floating loans, fixed loans come with a prepayment penalty of up to two per cent of the balance dues. Those wishing to move from a fixed rate to a floating one might also have to pay a switching fee, as applicable. The other caveat is that not all fixed-rate products are truly fixed, as they come with a reset clause. For instance, the fixed-rate home loan offered by ICICI Bank automatically shifts to a floating-rate loan after completion of 10 years.
"Consumers think if the rates are fixed, they can forget all about it. But that is not so; it's a decision that has to be continually reviewed," said Roongta. For example, if the consumer opts for a 20-year loan at a 10.5 per cent fixed interest rate and if the floating rates drop to nine per cent a year down the line, it might make sense to shift to the floating rate even if the customer has to pay switching fees.
Then & now
Fixed home loan products have not been popular with customers, historically. Until 2000, all home loans were given at fixed rates, after which the market shifted to variable home loans. In 2004-05, banks offered 20-year fixed home loans at seven to eight per cent, about 50-75 bps higher than floating home loans at the time. Those who opted for fixed loans at the time benefited immensely, as interest rates rose sharply in subsequent years and touched double digits. "This was the only time fixed rates made sense, as interest rates were at their lowest. But even back then, the product was not popular among customers," said Roongta. "Post that, fixed rates have never made sense and I doubt they will work now."
Besides Axis, ICICI Bank, HDFC and PNB Housing Finance also offer fixed-rate products. However, these differ substantially. ICICI Bank offers a fixed 10.25 per cent for loans up to Rs 1.5 crore for 10 years, after which the loan shifts to a floating rate, which is the base rate plus 0.25 per cent. The bank has no limit on the loan amount and the interest rate varies from 10.25 per cent to 11.25 per cent, depending on the loan amount. HDFC offers a fixed rate that is reset to floating after two or three years, with interest rates varying between 10.25 per cent and 11.5 per cent, depending on the amount. PNB Housing Finance offers different fixed periods of three years, five years and 10 years, with interest rates varying between 10.5 per cent and 11.5 per cent.
