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Rise in the repo rate: Should you opt for a fixed rate mortgage?

The Reserve Bank of India (RBI) raised the repo rate in May and June by 90 basis points as inflation intensified. Two consecutive rate hikes by the RBI indicate that inflationary pressures are here to stay. Further rate hikes are expected and necessary to control inflation. Following the changes to the repo, lenders passed on rate increases to home loan borrowers. This has led to longer loan terms or higher EMIs for borrowers with variable rate home loans. Just two months ago, mortgage rates were at their lowest in ten years.

The 40 basis point rise in May resulted in the lowest mortgage interest rates, rising from 6.8% to 7.2%. With the latest hike of 50 basis points, the lowest rates will now be around 7.3 to 7.7%. Given further hikes of 50 to 75 basis points this fiscal year, the lowest rates could reach around 8.5%. This will impact households. With this rapid increase in rates, anyone who had financed at a floor rate for the past two years could soon be faced with a hundred or more additional EMIs.

For example, for a loan of Rs 50 lakh at 7% over 20 years (240 months) one has an EMI of around Rs 38,765. Assuming the same EMI with a rate of 7.5%, the term of the loan will increase almost 23 months. At 8.5% with the same EMI, the duration will increase by about 10 years.

In the current interest rate scenario, many borrowers are wondering if they should switch to a fixed rate loan to protect against interest spikes. To help you decide, here we discuss some crucial tips for fixed and variable rate home loans.

Interest rate

The interest rate is important in determining your equivalent monthly payments (EMI). Therefore, you need to understand fixed and variable rate home loans. As the name suggests, a fixed rate home loan has a fixed interest rate for the entire term of the home loan. It does not fluctuate with market trends, so it provides a sense of stability to the borrower. It helps you plan your monthly expenses as the repayment amount remains unchanged.

On the other hand, the interest rate of variable rate home loans fluctuates according to the market situation. The interest rate is linked to a base rate and a floating rate. So when the base rate changes, your variable rate is also revised.

Now what is the difference between them? A fixed rate home loan is usually much higher than the variable rate. For example, a private bank announces a lowest variable rate of 7.60% and a fixed rate of 12%. This means that you will have to pay a higher EMI than an adjustable rate mortgage. Also, when the rate drops, a borrower on a fixed rate mortgage cannot benefit from lower rates. The table below will give you a fair idea of ​​the difference.

10 lowest floating home loan rates

Bank name Home loan under Rs 30 Lakh (in % pa)
central bank 6:85-7:30 a.m.
UCO Bank 6.90-7.10
Bank of India 6.90-8.75
BIO 7.05
Canara Bank 7.05-9.30
Karur Vysia Bank 7:15-9:35 a.m.
Bank of Maharashtra 7:30-8:85 a.m.
Indian bank 7h40-7h90
Bank of Punjab and Sindh 7h40-8h50
Union Bank of India 7h40-8h90

BANKS (fixed rates)

Axis Bank 12
IDBI Bank 9.85-10.10
Union Bank of India 11.4

Note: Fixed interest rates are subject to review after a fixed term. Rates may only apply for a fixed period and become floating thereafter. Data taken from the respective bank’s website as of June 17, 2022. Contributed by BankBazaar.com

Inflation protection

With rising inflation, the cost of living is also rising. In this scenario, it makes sense to always stick to avenues that help you have more money. A fixed rate home loan can theoretically protect you against rate volatility. However, if the price is already well above the floating rates, that won’t really help. This helps in a scenario where floating rates have increased exponentially due to inflation, outpacing fixed rates. It’s an unlikely scenario. If you had taken out a fixed rate loan in the last 2-3 years, you would have paid a substantial premium over the floating rates which have fallen to 6.40. And in a scenario where your fixed rate falls below floating rates, your gains may still be limited since you have paid a substantial premium before that point. Second, the variable rate may fall further after an inflation spike, but your fixed rate will remain high.

Prepayment charges

Prepayment charges refer to the amount you will have to incur if you want to pay off your debt faster. Depending on the lender and the terms and conditions, there will be prepayment penalties on a fixed rate home loan. Many banks charge a refund fee of up to 3% of the outstanding amount. In contrast, at a variable rate, there are no such fees for prepayment or pre-closing the loan before the term of office. There will be a small simple interest payment. It is lower than the fixed penalties.

Refinancing costs

Home loan refinancing helps you pay off your existing home loan by taking advantage of a new home loan that offers a lower interest rate and better terms. Refinancing helps borrowers by moving them from a higher interest rate to a lower interest rate with flexible repayment terms. This contributes to their long-term savings. You can switch from a floating interest rate to a fixed interest rate and vice versa. However, this conversion comes with a cost of up to 2% of the total loan amount. This means that on a loan of Rs 30 lakh, you can pay up to Rs 60,000 as a conversion fee. Therefore, before availing the refinance facility, it makes sense to do your math to understand how much you will have to shell out as conversion fees and how much interest you will save.

When does the fixed rate mortgage work?

Home loans are usually repaid over a long period. During this period, interest rates may experience several cycles. With a variable rate loan, you will benefit from lower rates while being able to repay the loan early without penalties. In contrast, in an extreme inflation scenario where rates drop from historic double-digit lows, there may be some short-term protection with a fixed-rate loan. Car and personal loans are examples of fixed rate loans. These are short term loans. Fixed or floating, there won’t be much difference in interest. So it doesn’t hurt to lock in a fixed rate and hedge against short-term rate volatility. In some rare scenarios, this may also be true for home loans. There may be a small possibility that fixed rate loans will work for some short-term borrowers when inflation spirals out of control and floating rates rise exponentially. But borrowers need to do the math and verify this assumption. For most borrowers, that probably won’t be true. In most cases, a variable rate loan with the option of pre-payment and pre-closing is preferable.

The author is the CEO of BankBazaar.com. The opinions expressed are those of the author.

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