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Most home loan borrowers opted for floating rate loans in the past five years. Unfortunately, banks increased the rate on these loans three to four times in the one and a half years. Now, the borrowers are feeling the heat of increased rate of interest.

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Those who thought themselves to have sailed safely by buying floating rate loan at 7% in 2003 are now highly tensed. Most banks are charging around 11.50% interest rate.

Let's take a case supposing home loan amount to be Rs 10 lakh and the tenure as 20 years. With the increased rates, the EMI changes from Rs 7,753 to Rs 10,000 or if one wants to keep the EMI amount same, the tenure would increase by more than 10 years.

Kind of Options Available

It is always adviseable to pre-pay any loan, including the best home loan, if you have extra cash available with you. Most people think that the principal amount outstanding has not reduced even after paying EMI for three to four years.

Considering the above example again, if the borrower prepays at the end of fourth year, the outstanding principal is still around Rs 9 lakh. The borrower is repaying a higher proportion of interest in the initial EMIs. The interest can hover anywhere around 80% in the beginning.

Interest component falls down and principal component goes up as a proportion of the EMI with the loan tenure. For that reason, many of home loan borrowers assume not to prepay an apt way, say, after half way through the loan tenure, because the interest falls.

The interest outgo as a percentage on outstanding principal will remain same every time. As home loan rate is evaluated using reducing balance method, the interest rate is always evaluated on the remaining outstanding principal.

Now, the interest which requires to be distributed accordingly in the remaining tenure would also be low, resulting in lower interest amount component. However, there would come no change in the rate of interest which will remain same at both the periods.

Your home loan tenure should not be a driving factor for you to narrow down on the option of prepaying the loan. It should largely depend on current interest rate and the amount of spare cash with you.

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Once you decide to avail a home loan, the next thing that storms your brain is choosing between fixed and floating rate of interest. And here is where you are caught in a catch 22 situation.

Guide2homeloan Articles ▪ Home Loan Articles ▪ Home Insurance Articles

Usually, when news media splashes reports on banks increasing home loan interest rates in India and their impact on Equated Monthly Installment (EMI), you deem it better to opt for fixed home loan rate. In fact, your banker may also advise you to go for the same.

Now ideally as it should be, we assume that once you select fixed rate plan for yourself the rate of interest will remain unchanged over the entire tenure of the repayment period irrespective of any subsequent increase in the same. But actually this is not the case.

Here we demystify the nature of fixed interest rate housing loan transaction for you so that you could make an informed decision over the matter.

• All the banks include the reset clause on fixed interest rate in their home purchase loan agreement papers. So if you had taken the loan @ 10.5 per cent for 15 years it does not mean that the same rate will be applicable all across the period.
• India’s largest public sector bank State Bank of India (SBI) has introduced a clause as per which it has right to revise the fixed rate home loan after two years. Similarly, Canara Bank and Corporation Bank also have similar provisions to revise the rates after 5-years of disbursing the loan.
• Private sector banks and Non Banking Financial Corporations (NBFCs) are also following the same policies and the rates too are revised from time to time.

Force Majeure Clause

So, while you read your home loan agreement papers, you can spot statement like this:

“Provided further that from time to time, the bank may in its sole discretion alter the rate of interest suitably and prospectively on account of change in the internal policies or if unforeseen or extraordinary changes in the money market conditions take place during the period of the agreement.”

This is called Force Majeure Clause that enables the lender to undertake appropriate modifications in the interest rates on home loans they sanction to their borrowers.