Home Financing: Fixed Vs. Floating

The Housing Loans always surprises you with Fixed Rate for a minimum period and then floating subsequently. Industry parlance they call it teaser rates. It is good strategy for amassing assets for the Home Loan company/bank. but what is it for you?

Teaser loans are offered as adjustable-rate loans, in which the borrower pays low initial interest, which increases after a few years. They try to entice borrowers by offering an artificially low rate and small EMIs (Equated Monthly Instalments) for initial 2-3 years; for the balance tenure, prevailing interest rates at that time would be applicable. SBI brought it during 2009.It was withdrawn in April 2011and added a feature of refinance or re-pay without charges any time.






Dual rate loans charge a fixed rate of interest for the initial period and then floating rate.According to NHB guidelines, there is no prepayment penalty on floating rate loans, irrespective of the source of funds used for prepayment. But for fixed rate loans, there is a penalty if the funds are borrowed from some other source, that is, if it is refinanced. For teaser loans, lenders can charge a penalty for prepayment if it is refinanced, similar to fixed rate loans. Reason: The loan was charged at a fixed rate of interest at the time of approval, the NHB circular said. HFCs are required to make an additional provision of two per cent for these loans as they carry interest rate risk as well as some credit risk.

This additional provision has to continue for at least one year from the change to floating rate. That is why once the loan moves to floating rates, there has to be some balance to ensure the viability of the loan (both on individual as well as aggregate level) and the system. Besides the interest rate risk, there are other inherent risks in the teaser loan products, such as the asset-liability mismatch, and even potential default risk. These have to be factored into the business model, in the larger interest of viability and sustainability.

When the rate changes from the fixed rate to the floating rate and the monthly repayment remains unchanged then, the tenure goes up substantially. As the difference between floating and fixed rate is 1-1.50 per cent (current floating rates is 10.5-11 per cent and fixed rate 12.5 per cent), it is natural teaser loan borrowers would want to move to another institution for a near market rate. If the rate goes up by two per cent in 24 months, the tenure can go up from 20 to 40-42 years.

If the lender allows conversion (reset rate), then it makes sense for the customer to opt for it rather than refinance it. Those who move to a new lender will require to pay a processing fee. So, customers must also look at the benefits they get from their own lender before going in for refinance.

Happy investing