If you have been following the newspapers closely you would have realised by now that a lot of public sector banks have started bringing down the interest they pay on their fixed deposits. At the same time they have made it clear that they will not bring down their lending rates.
One of the impacts of this decision would be that the equated monthly instalment that individuals pay to repay their floating rate home loans will not come down.
Home loans are largely of two varieties - floating and fixed. Floating rate home loans as the name suggests are not fixed. They are linked to what is known as the benchmark prime lending rate of a bank or the housing finance company from which you take a home loan.
Hence if the BPLR is 13.5 per cent and floating rate home loans are at a discount of 1.5 per cent to the BPLR, then the interest rate on a floating rate home loan is 12 per cent. So whenever the BPLR is raised, then the interest to be paid on the floating rate home loan goes up. The vice versa also holds true.
When the interest rates at which banks and housing finance companies raise money are on their way up, they show amazing alacrity in increasing the BPLR. Hence increasing the interest on the floating rate home loans for existing customers.
This speed was clearly visible as the interest rates on existing floating rate home loans increased from 7.75 per cent levels to nearly 12 per cent currently, in a span of around 18-20 months, from October 2005.
But the same alacrity and speed is missing when it comes to reducing the BPLR when interest rates start coming down, as they have now. In order to get new customers the banks may even come up with a new BPLR, so that they can offer these customers a lower rate. But the existing customers continue to pay a higher rate of interest.
Given this behaviour of banks, it can safely be said that when interest rates are on their way up, floating rates are clearly floating, but when interest rates are on their way down, they tend to become fixed.
Now one way of avoiding all this, is by taking a fixed rate home loan. In fixed rate home loans, the rate of interest decided on at the time of the customer taking the loan, should be fixed across the period of the loan.
But that clearly does not seem to be the case. Most fixed rate home loans, these days come with a reset clause. This allows the bank or the housing finance company giving you the loan, the right to increase the interest rates, after a certain period of repayment is over.
This period typically varies from 2 years to five years depending on which bank or home finance company you approach. But the point is that if interest rates go up, the banks or the housing finance company can increase the rate of interest even on a fixed rate home loan.
So when negotiating for a fixed interest rate home loan, do find out whether the loan has a reset clause. If the answer is yes, then find out, after what time frame does the clause becomes active. Once you have the answer to this question, you can figure out whether it makes sense to pay a higher rate of interest on a fixed rate home loan or take a floating rate home loan instead.
Hence as weird as it may sound, as far home loans in India are concerned, floating can be fixed and fixed can be floating.
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