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Fixed or floating, which way should one go?

As interest rates are on an upward trend and there are no signs of any rate cut soon, both first-time home buyers and other home loan borrowers should look forward to availing fixed-rate loans, instead of floating-rate loans

May 20, 2022 / 01:33 PM IST

The Reserve Bank of India (RBI) recently increased the repo rate by 0.40 percent, given the ongoing inflation onslaught.

Most financial pundits were expecting a rate hike, but not before June 2022. However, the Monetary Policy Committee (MPC) took everyone by surprise, and cited various factors for the hike.

The first is the Consumer Price Index (CPI) inflation. It is at a 17-month high of 6.95 percent for March 2022. At the same time, the Wholesale Price Index (WPI) inflation rose to a four-month high of 14.55 percent, compared to 7.89 percent in the corresponding period of the previous year.

A rate hike after four years

Given the recent rise in interest rates, the cost of availing a loan is expected to grow even higher in the coming months. For most of the small-ticket loans, the hike will play a crucial role in the overall cost of availing funds.

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As far as home loans are concerned, the rate hike is expected to drive growth in the real-estate market, which has been seeing a stagnation for almost three years.

Before and during COVID-19, the cost of acquiring property was low, as the markets were flooded with unsold inventories and buyer sentiment was poor. Accordingly, most builders sold the existing inventory without taking enough margins.

Global factors affecting real estate

At a time when the global supply chain is disrupted by the ongoing Russia-Ukraine war and post-pandemic logistical issues, prices of commodities like cement and steel have gone up by 6-8 percent, and builders have no option but to pass it on to the consumers.

Conversely, some real-estate consultants suggested that it would boost consumer sentiment even further, as property prices were not showing any sign of improvement before the pandemic, and with the availability of excess inventory, rates were highly competitive.

Key takeaways for home-loan borrowers

In the coming months, the central bank plans to curb inflation with subsequent rate hikes, and it is also putting a mechanism in place to absorb excess liquidity from the markets, especially from public and private banks.

The annual wage growth in the country stands around 10 percent, while inflation is around 7 percent. With some banks hiking MCLR (marginal cost of funds based lending) rates, realtors expect borrowers to absorb the inflated inventory costs.

Let’s take an example to understand the impact of rate hikes on a home loan EMI:

Amount availed: Rs 30 Lakh for a tenure of 10 and 20 years, at the current rate of interest, compared to how it would be one year down the line and a fixed-rate loan for the entire repayment tenure.

TENURE TABLE GFX 1

For a 10-year period in a repo-linked floating rate, a borrower will be spending Rs 1,449 extra in EMIs and Rs 1,73,903 in overall interest payment. Floating rates were more beneficial so long as the interest rates were kept at a bare minimum due to the pandemic.

TENURE TABLE GFX 2

Now, considering a scenario where the repayment tenure is 20 years, the difference between a floating and the fixed-rate EMI comes to Rs 1,717, and the interest payable would be Rs 4,12,110 more than the other.

Also read: With home loan rates going up, is it time to move to fixed-interest-rate loans?

Fixed or floating? Think wisely

As the interest rates are on an upward trend and there are no signs of any rate cut in the near future, both first-time home buyers and other home loan borrowers can look forward to availing fixed rate loans instead of floating ones to save a decent sum in EMIs & interest payments in the longer term.

Currently, however, it may be difficult to find a long-term fixed rate loan. Once inflation is under control, borrowers can make use of the transfer facility to convert their fixed-rate into floating rate, if the difference in rates continues to make financial sense.

There will be new launches and buyer participation will increase. The increase in raw material and commodity prices is already impacting property prices. As a safeguard, borrowers must act wisely and save whenever possible. In our case, it’s the fixed rate, instead of a floating rate, that is serving you better. The most defining factors would be the buyer’s attitude and an investor’s farsightedness on how they manage their finances, going forward.
Raj Khosla is MD, MyMoneyMantra.com
first published: May 20, 2022 07:41 am
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