Choose the best home Loan option with rising Interest Rates
Over the last couple of years, interest rates on home loans have been increasing gradually. Rising interest rates present a difficult situation for new home loan borrowers. The dilemma is whether to opt for the floating rate loan or the fixed rate loan, or the hybrid loan. Under a fixed rate of interest option, the rate of interest is decided before hand, at the time of taking the loan. The rate remains the same during the life of the tenure of the loan irrespective of the market rates of interest.
In case the interest rates go up, the borrower still pays on the agreed lower rates of interest. In case the interest rates go down, the borrower tends to lose as he has to pay a higher interest as compared to the market rates of interest. In case of floating rate loans, the rate of interest is linked to the market rate or a benchmark rate, for example, the prime lending rate of the bank.
Thus, a borrower floats along with the market rates of interest and has to constantly monitor the market movement of interest rates. Then there is the hybrid loan. These loans combine features of more than one product. Simply put, traditionally, one could opt for either a fixed rate loan or a floating rate one.
Hybrid loans combine the features of both the loans.The variants may be different. Such loans are offered in addition to the traditional pure loan products. The borrower has a choice of which loan he wants to opt for. Each product introduced by the different banks has its own distinctive features.
Some banks offer a certain percentage of the loan amount to be at fixed rate of interest and the balance at floating rate of interest. Others offer a fixed interest rate for the first few years - 3-5 years and then it would be floating - depending on the market rates of interest.
The interest rates will remain fixed for the first few years of the loan tenure only. After this initial period, the loan becomes a floating rate loan, and the applicable interest rates at that point of time will be applicable to the balance loan amount. While taking a decision, a borrower faces a dilemma - which loan to choose. Should he go in for a fixed rate loan or should he go in for a floating rate loan, or a hybrid loan. Some risk is involved in all the cases and the borrower needs to take a conscious decision after analysing some factors. Although there are no hard and fast rules to predict rate movement, a borrower would do well to analyse the general trend.
The matter gets complicated in case of an increasing interest rate scenario. Here are some factors to be considered… The decision would depend on a host of factors. One is the risk appetite of the borrower. How much risk can he take? How much can he bear in case the market conditions become adverse? Can he still service the debt in case the interest rates keep increasing? Another important factor is the tenure of the loan. In case one is looking at a longer tenure, then opting for either a floating or a hybrid product makes sense, because the high interest rates may not be sustainable in the long term.
The credit policy statements by the Reserve Bank of India give an indication of the expectation and intention on the direction of interest rates. In the latest credit policy RBI has given an indication of softening of home loan by reducing the capital requirements for banks to give home loan.
This indicates the cost of borrowing for the banks. This cost increase if any can be expected to be passed on to the borrowers as well. Similarly, increase in the cash reserve ratio of banks signifies that the liquidity position of banks would be reduced and hence with lesser funds in the market the cost of borrowing i.e. interest rates would go up. Another important indicator would be the long-term deposit rates offered by banks. This would give an indication of the banker's expectations of interest rates over that time period.
Going by the present trend, it seems the cost of funds, especially housing loans, may just have peaked. There may not be much scope for further increases in the interest rates in the near future.
On the contrary, the only way for interest rates to move in the near future may be south-wards . This is because of the adverse affects it has on the economy. The RBI and Finance ministry are already taking steps to control inflation. Once this is done, the interest rates will come down.
