It's time to take floating interest loans in India

A cumulative 4% interest rate hike for home loans in the past two years has caught many floating rate borrowers on the wrong foot. Yet, today, floaters seem the best option for new home loan takers, all thanks to near-peaking of rates. Any further fall in interest rates will also directly benefit them.

The news that HDFC has cut home loan rates by 0.5% on all fresh loans up till October 31 is all over the newspapers and TV channels. But existing customers are not affected by this and prime lending rate (PLR) has also been maintained at the original 14%. However, this report has cheered up new home loan takers. Home loan rates have seen several highs and lows in the past few years. Rates halved to 7% in '03 from 14% in '00. Then the floating rate curve began to go up and settled at 10-12% in January '07. That's almost a hike of 3-5% in the past four years. Now, what you need to know is whether the rising trend of interest rates will continue? Also, if you plan to go in for a home loan now, should you float or fix yourself at a particular rate? Industry experts say even today, a floating rate is a safe option for borrowers due to several reasons:

Interest rates may not rise much further

Most industry experts are of the view that the rates are likely to stabilize at these levels. A senior public sector banker explains any further rate hike will pinch customers' pockets even harder. "This, in fact, is likely to hurt the economy as a whole, since even the corporate sector will come under pressure. So, we do not foresee any further rate hikes. However, we will get an accurate idea only by November. So far, the credit pick-up has been low, which traditionally tends to peak only in the festive season beginning November. But there have been concerns about rising inflation and high liquidity, which may prompt the Reserve Bank of India (RBI) to hike the cash reserve ratio (CRR), which may impact the rates. Even in that case, the hike in rates will be very marginal, in the range of 0.25-0.5%," the banker adds.

True fixed rate comes at a high premium

After being impacted by the volatility of home loan rates, customers now feel it's best to opt for a fixed rate product. The obvious explanation being that although a partly-fixed rate typically is 1.5-2% higher than the floating rate, at least borrowers are spared from frequent rate hikes. But that's just one side of the coin. Says home loan expert and apnaloan.com CEO Harsh Roongta, "As of now, it makes economic sense to go for a transparent floating rate. The gap between a pure fixed rate and a floating rate is almost 2.25%. It's too high a premium to be borne by a customer." Mr Roongta explains that unless floating rates touch 13-13.25%, borrowers need not worry and lock in at a fixed rate.

Your fixed rate isn't really that

In India, fixed is never fixed. So, it may just happen that your floating rate of interest on the home loan does not go down after an overall fall in interest rates.

Here, it is essential to explain the difference between a fixed rate and a true fixed rate.

A fixed rate which is linked to the money market condition has a reset clause. This implies that the bank or housing finance company (HFC) can tinker with the interest rate in extreme market conditions. State Bank of India (SBI) introduced the reset clause in August '05 and now, the period is two years. Other public sector banks like Canara Bank and Corporation Bank have a reset clause period of five years. To that extent, if there is a rate change during the period when the reset clause does not come into effect, the rates remain unchanged even if the floating rate interest rates go up.
On the other hand, in case of a true fixed rate product, the bank or HFC does not stand any chance to tweak the rate.
Few leading housing finance companies like HDFC offer the true fixed product. This product charges a higher interest rate than the partially fixed product.
All said and done, there is no single answer to the question: should home loan takers go in for a fixed or floating interest rate?
The answer changes from time to time. It would have been ideal if you fixed your rate at 7% in '03. That's because it is unlikely that interest rates will dip to those levels any time now.
Now, you should go in for a floating rate as interest rates have almost peaked. So, there is no reason for you to lock in yourself at a higher interest rate.
Also remember, your job is not over once you start repaying your home loan. You should ideally review your rates every six months.
That will help you to figure out an effective repayment plan for your home loan.