About 18 months back, she had taken a 20-year, floating rate home loan of Rs 20 lakh from a leading private sector bank at an interest rate of 7.75%.
MUMBAI: Shalini Saxena is a worried woman. Every time she wakes up from the wrong side of the bed, the equated monthly instalment (EMI) on her home loan seems to go up.
About 18 months back, she had taken a 20-year, floating rate home loan of Rs 20 lakh from a leading private sector bank at an interest rate of 7.75%. This had involved paying an EMI of around Rs 16,400 per month. Now, a year-and-half down the line, the interest rate on her home loan had gone up to 11.25%. Initially, it had not mattered much as the bank had raised the tenure of the loan keeping the EMI constant. But the rates had gone up so fast that after a point, the bank simply could not keep raising the tenure anymore. And then, it had started increasing the EMIs. So much so, from this month, she would have to pay an EMI of around Rs 19,500 per month. This EMI would, of course, stay put, till she woke up from the wrong side of the bed again.
Shalini had done her research before taking the home loan. Most expert advice had been to take a floating rate home loan. The logic given out was that the interest charged on a fixed rate home loan is 1-1.5% higher and there was no point in paying a higher EMI from the very beginning.
This, as she now realised, had turned out to be wrong. Had she taken a real fixed rate home loan back then, she would still be paying an interest rate of 9.25% on her home loan. Or, would she?
A fixed rate loan offers the assurance of the interest rate remaining constant over the period of the loan. In other words, the EMI should remain the same over the entire period of the loan. However, some banks and housing finance institutions build in a reset clause into the home loan agreements, which allows them to increase rate after a period of two to five years in case there is any adverse movement in interest rates.
An option for Shalini now was to convert to a fixed rate home loan. But, after running some numbers she came to the conclusion that this wasn’t feasible at all. Real fixed rate home loans were currently at around 13.25%. So, converting to a fixed rate loan would lead to the EMI increasing by around Rs 2,000 more. What’s more, she would also have to pay a conversion charge of 2% on the current principal outstanding of around Rs 19.4 lakh, which worked out to around Rs 38,800.
This would be beyond her considering all her savings had gone into making the down-payment for the house. In fact, the lack of savings also obviated the possibility of prepaying a part of the loan to maintain her current EMI.
All this led Shalini to believe that she had no choice but to continue paying a higher EMI every time the interest rates went up. But there had to be some learning from this experience.
Driving home the same evening, she saw a billboard advertising a 50:50 home loan. With a little bit of research, she realised that she should have taken a 50:50 loan, which would essentially be part-floating and part-fixed. On her loan of Rs 20 lakh, this would have meant taking Rs 10 lakh on fixed rate and Rs 10 lakh on floating. The effective interest rate would then be the average of the two interest rates.
By taking a 50:50 loan, she would have started the repayment at an interest rate of 8.5%, or the average of the floating rate of 7.75% and fixed rate of 9.25% [(0.5 (7.75% + 9.25%)]. This would have meant an EMI of around Rs 17,350, around Rs 1,000 higher than what she started out with. Had the floating rate dipped to say 7%, she would be paying a higher interest rate of 8.125% [0.5 (7% + 9.25%)], giving a feeling of having lost out further. But, at least, a rise wouldn’t have pinched her so much. Given that the floating rate was now at 11.25%, her liability would be 1% lower at 10.25% [0.5 (11.25% + 9.25%)]. A 50:50 loan would thus have been a sensible option, the more so because nobody knows which way the interest rates would move next.
Also, Shalini could well have prepaid the 50% of the loan that was floating, without having to pay any prepayment charge. Most banks and housing finance companies levy a 1.5-2% prepayment charge on fixed rate home loans, though housing finance companies like Housing Development and Finance Corporation allow prepayment of up to 25% of the loan outstanding at the beginning of a particular year, even on fixed rate home loans.
The wrong was done for now, thought Shalini. But, it was a learning experience, nonetheless. Surely, she would be wiser the next time.
The example is hypothetical
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