Home Loan Interest Rate - Floating or Fixed?

It is very difficult to answer the question, is that not so? After all, interest rates have been on a roller coaster ride over the past five years or so. From 14 per cent in 2000 to 7 per cent in 2004, the current home loan interest rate is ten per cent and it is set to go up further any time now, with the stringent credit policy measures announced recently by RBI in order to bring down the current inflation rate of over 6% and stabilize it around 5%. What should a potential home loan consumer do? Lower floating rate with the risk of being done in by a huge increase in interest rates in the future or a fixed rate with the relative safety attached to it, but at a price?

The fact that the Indian economy has been growing at a hectic pace of 8-9% per annum is leading to more demand from corporates for money for expansion plans. However, RBI has been taking conscious steps in its successive quarterly reviews of annual credit policy to curb the inflationary tendency in economy but there is always a lag before these measures will have their desired effect. Once inflation rate is brought down, the interest rates must follow suit and RBI can be expected to enable such a scenario. My own gut feeling is that it will be sooner than later and I am willing to stick my neck out and say that the interest rates could just have peaked or close to it that it can only come down from there. Further, the US economy could soon be opting for a slowdown leading to a softening of interest rates there and it could have a ripple effect on interest rates back home. Let's see how it pans out in the next few months!

In the current economic scenario, I would personally opt for a transparent, floating rate home loan. By transparent floating rate, we mean that the potential consumer should know the benchmark rate like PLR, FD rate, etc to which the floating rate is linked to, so that he/she can ensure that he/she gets the benefit of a reduction in the benchmark rate as and when that happens. My preference for a transparent floating rate home loan over a true fixed rate home loan is for the following reasons:

• It is a simple physical law that what goes up must come down and interest rates are no exception. Floating rate will enable me to use that to my benefit.
• Floating rates at any point of time are at least 1.25 per cent cheaper than a true fixed rate home loan for a comparative tenure.
• Even if the interest rates rise in the immediate future, I have a cushion of 1.25 per cent and it will not hurt me as long as it is within this limit of 1.25 per cent.
• Housing sector must grow to fuel the basic industries like Cement and Steel that lead the economic growth and no government worth its salt will take any steps to drive the individual home buyers from the market with high interest rates. The recent RBI steps have, therefore, been to curb the tendency on the part of the builders and the middlemen to jack up the prices through artificial demand, rather than hurt the individual home buyers. My guess is that the RBI policy will do a good turn to the individual home buyer soon.
• There has been a correction in the Real Estate market and the prices have come down by 10-20% recently. This could well indicate that the grip of artificial demand created by middlemen through cornering of new housing space with the help of bank loans is loosening. A logical corollary is that there is likely to be less pressure on bank funds from this segment and this is one of the objectives of the recent RBI steps.
  

If anyone still wants to go in for a fixed rate home loan, then he/she should seek to know from the bank and understand whether it is fixed for the life time of the loan or if it is fixed only for an initial period of three to five years. If it is fixed only for a limited period, the rate is not a true fixed rate home loan. I am saying this because even if the rate is said to be fixed for the entire tenure, there could be a clause tucked away in an obscure corner in the loan agreement allowing the bank to review and increase the said "fixed rate", subsequently!