Know your loan

FIXED OR FLOATING RATE?

The first decision for a borrower to make is whether to opt for a floating- or a fixed-rate loan. During the boom in real estate between 2004 and 2007,most of the of home buyers in India opted for floating-rate loans. Many of them have lived to regret the decision. The reason: banks in India are quick to hike rates when interest rates are rising,but slow to lower them when rates are falling.

Whether to opt for a floating- or fixed-rate loan should depend on ones risk appetite. Fixed rate loans are usually 1.5-2 percentage points more expensive than floating-rate loans. Despite this higher charge,they might be worthwhile because they allow you peace of mind. Since you know what your home loan liability will be,you can plan your finances with a high degree of certainty. By contrast,in the case of floating-rate loans,a sudden spurt in rate can cause your household finances to go haywire,as many households have experienced in 2007-2008 when rates were going up. So,opt for a floating-rate loan only if you have some financial cushion,and can pay the higher equated monthly installment EMI if interest rates go up.

Moreover,the decision to go for a floating- or fixed-rate loan should not be cast in stone; it should be reviewed from time to time,according to changing circumstances.

WHERE ARE INTEREST RATES HEADED?

Will interest rates fall further in which case you could opt for a floating-rate loan,or have we come to the end of interest rate cuts in which case a fixed-rate loan would be advisable? The benchmark repo rate has been falling since October 2008. So far it has come down by 4.25 percentage points from its peak of 9 per cent in October 2008 to 4.75 now. The RBI has been cutting rates in order to stimulate demand and bring about faster recovery within the economy. Could there be more rate cuts? Perhaps yes. With WPI inflation at below 1 per cent,there is scope for further cuts. But one also cant expect rates to fall much. The governments heavy borrowing due to its high fiscal deficit will not allow interest rates to decline beyond a point.

What also needs to be noted is that while the RBI has cut the benchmark repo rate by 425 basis points from its last peak,banks have reduced their home loan rates by much less. Banks may cut their own rates further to stimulate more borrowing. But will they? When it comes to cutting rates,banks claim that their cost of funds is high. Says Mrunal Duggar,associate director-Homebay Residential,Jones Lang LaSalle Meghraj,We will not see all-time lows of 7 per cent again. More likely,interest rates are likely to be between 8.5 and 10 per cent.

Predicting interest rate movement is a hazardous business and catching the bottom is next to impossible. If you are a conservative borrower,go for a fixed-rate loan,and if you have an appetite for risk,opt for a floating-rate loan. And review the decision periodically.

PREPAYMENT CHARGE

To allow yourself the freedom to switch from one borrower to another,find out what the prepayment clause says. Read the loan document of the bank from which you wish to take the loan. Most banks allow you to make part prepayment,i.e.,you can reduce the principal outstanding whenever you get a windfall,say,in the form of a bonus from your employer. But when it comes to full prepayment a situation that usually arises when you wish to shift the loan from one lender to another public sector banks may allow you to prepay without charging you a penalty,but private sector banks are likely to charge you one. A few lenders have in recent times increased their prepayment penalty rates to discourage existing customers from shifting. HDFC and ICICI Bank have increased the prepayment penalty from 2 to 3 per cent and 2.25 per cent respectively.

SWITCH OPTION

While interest rates are going downward at present,one doesnt know whether they will fall further and by how much. If you are the conservative sort,you may opt for a fixed-rate loan today. But later,if home-loan rates decline aggressively,you may want to shift to a floating-rate loan to take advantage of the decline. Conversely,you could opt for a floating-rate loan today. But if,a few years later,rates begin surging upward,you may want to switch to a fixed-rate loan. Find out what an internal switch will cost you. It is 0.5 per cent for some private players. One should establish whether the lending institution offers the option of switching from a floating- to a fixed-rate loan and vice-versa,and if there would be any cost implications, says Duggar

TENURE AND AMOUNT

Ideally,one should choose the smallest possible tenure. The longer the loan tenure,the higher your total interest outgo on the loan. A lot of people choose a longer tenure when they can afford a higher EMI and pay off the loan within a shorter duration. They do so because it leaves them with more money to fund their other expenses. This should be avoided.

Some people also make the mistake of taking too big a loan,or too high an EMI. Instead the borrower should take into consideration his net cash flow. Going for a high loan simply because you are eligible for that amount according to the banks calculations is not advisable. Though the bank may lend on the basis of your repayment capacity,which they work out to as much as 55-60 per cent of your monthly income,in my opinion,one should make sure the total cash outflow towards the EMI does not exceed 30-35 per cent of ones monthly net cash income. One also needs to take care of unforeseen fluctuations in salary income,like being handed a pink slip,and other necessities of life such as marriage,illness,etc, says Vishal Chopra,a chartered accountant and legal expert on real estate-related issues.

OTHER EXPENSES

You need to find out how much money you must have in your hand before buying a house on loan. First,you need the margin money,which is about 10-15 per cent of the total cost of the house. Banks will only lend you up to about 85-90 per cent of the total cost. Then there are other miscellaneous charges like loan processing fee,administration fee,etc.

SWITCHING LENDERS

At present,an interest-rate differential has developed between the rates of public sector players such SBI and LIC Housing Finance and private banks. A lot of existing customers are thinking of shifting their loans to public sector lenders. According to experts,switching from one lender to another makes sense only when there is an interest differential of at least 1.5-2 percentage points. There is a prepayment penalty of 2 per cent to be paid to the existing lender. Moreover,it makes more sense to switch early in the loan tenure. Thats when the interest component of your EMI is high and the principal component relatively small. Harsh Roongta,CEO of apnaloan.com,says,If switching or restructuring home loans were so easy on pockets,every other person would opt for it. Roongta cautions home loan takers that its important to read the agreement papers before signing in for a home loan.

For all those who are planning to take a home loan,understanding the concerned issues and making the right decisions is very important as this has financial ramifications for the next 15-20 years. l

praveen.singhexpressindia.com