Attractive teaser rates

Then there is a third class of customers that doesn’t believe that its economic situation will worsen here onward,but it doesn’t possess much surplus that would enable it to tide over the burden of a higher EMI in case interest rates rise.

Both the second and the third category are sitting on the fence and are unwilling to take a home loan. It’s to entice these two classes,who are worried about how they will service their EMIs if they take a floating rate loan,that a number of public sector players like State Bank of India (SBI),Canara Bank,and LIC Housing Finance have launched home loan schemes where the interest rate remains fixed for the first few years,after which the borrower is shifted to a floating or fixed rate — at the rates prevailing then.

Customers’ dilemma

The floating-rate loan is available today at about 9.25-10.25 per cent,while the fixed-rate loan is available at around 2 per cent more. Besides,most fixed-rate loans in India are not truly fixed; most of them carry the money market clause (or the re-set clause),which allows the bank to change the interest rate periodically. Only a few players like HDFC,ICICI Bank,and Axis Bank offer the truly fixed-rate loan (without the money market clause). But at around 13.5-14 per cent,these are prohibitively expensive. Most customers are not comfortable paying the extra 2 per cent (for fixed loans with the money market clause) or 3.5-4 per cent (for fixed loans without the money market clause).

The fixed-cum-floating rate loan in part solves customers’ dilemma since the EMI remains predictable for the first three to five years. What makes these offers more attractive is that the rates being offered for the initial grace period (8-9.5 per cent) are lower than the prevailing rates on floating loans.

Further,according to Vishal Dhawan,a Mumbai-based financial planner,“These loan offers are also attractive for customers who are likely to pre-pay their loans. You lock into a lower rate of interest for three to five years. And by the time you get into market rates,your principal outstanding is not very large.”

Another advantage of these loans is that the mechanism for fixing the floating rate (after the initial grace period) has in most cases been clearly stated. According to Harsh Roongta,chief executive officer,apnaloan.com,“The public sector banks have clearly stated what the formula for fixing the floating rate will be. For instance,in the case of SBI,it will be linked to the State Bank Advance Rate (SBAR). This makes these loans more transparent than earlier when ABN Amro had offered a low initial rate but had only stated that customers would move to a floating rate.” (One would like to add here that while this is a step towards greater transparency,it is not the ultimate: banks do have discretion in fixing their internal benchmark rates. What would call for a celebration is if the floating rate is linked to an external benchmark,such as the Mumbai Inter Bank Rate.)

Whose offer is the best?

Before reading this section,do glance at the box given alongside (Fixed-cum-floating rate offers). Look at the effective rates for each player for the initial grace period. (The rate you will have to pay after the grace period can anyway not be predicted in advance.) Strictly speaking,you can compare the offers between SBI and LICHF,since both fix the tenure for three years. SBI’s offer appears to be marginally better for a loan of around Rs 25 lakh. LICHF doesn’t give a formula for fixing its floating rate. Canara Bank offers you peace of mind for a longer tenure of five years,hence its higher effective rate of about 9.05-9.45 per cent appears justified. A negative about Canara Bank’s offer is that its floating rate (from the sixth to 20th year) will never be allowed to fall below 10 per cent.

Where are interest rates headed?

One doubt that customers could harbour about the wisdom of locking themselves into the rates offered by these fixed-cum-floating loans is that interest rates could drop lower. That appears unlikely in the near future.

Several factors point to a rise in interest rates in future. The government’s high fiscal deficit,and hence its heavy market borrowing programme,is likely to keep interest rates from softening. Further,economists are concerned about the tidal wave of liquidity let loose by central banks in the West. This,it is feared,could stoke inflation,which would in turn lead to the Reserve Bank of India tightening rates. Says Veer Sardesai,a Pune-based financial planner: “I think we are quite close to the bottom of the interest-rate cycle. Interest rates are likely to stay here for a while and then head up,though it is admittedly difficult to predict interest-rate movements with certainty.”

A few caveats

Similar home loan products were offered in the US where the rates were enticing in the initial years. But when market rates kicked in,a lot of defaults occurred. (The difference between the US and the Indian situation,however,is that banks and housing finance companies here exercise much greater due diligence regarding whom they lend to.) Nonetheless,the basic lesson from the sub-prime crisis should not be overlooked: be conservative in assessing your repayment ability. Says Sardesai: “Before opting to take a home loan such as this,make sure that you have the ability to pay the EMI when the market rates kick in. If you can afford the market rate,then go ahead and take the benefit of these concessional rates.” Adds Dhawan: “Not more than 40 per cent of your take-home salary should go towards paying all your EMIs.”

In fact,in your calculations,you should factor in that over a 15-20 year tenure rates could rise much higher than the current levels. During the last upswing in the interest rate cycle,customers on floating rate loans had to pay interest rates as high as 13 per cent and more. But that was not all: the loan tenure too rose. So you had situations where on a 20-year loan,having paid the EMI for several years,borrowers still had an outstanding tenure of more than 20 years. Says Dhawan: “If you belong to the class of customers that doesn’t have too many other savings as backup,or if a large part of your income goes towards paying the EMI,be conservative. If both the partners earn today,but there is a possibility that the earnings of one of the two members could stop at some point in future,be warned.”

Apart from these caveats,these are good offers. Benefit from them. •

sk.singh@expressindia.com