Homes or immovable properties like land are big investments. It is not within reach of the common man to foot the entire bill on his own. Loans and the associated benefits come in like a saviour. But it brings in the complexities of understanding the basics of interest rates and making the right decision.
We at RoofandFloor believe in helping people make informed decisions. Hence we bring in this guide to understanding interest rates and how they affect your home loans.
Before you apply
Once you decide on buying an immovable property on loan, the first step would be to check for your eligibility.
Factors like your income, existing loans being repaid, your job, spouse/co-applicant’s income, and your credit score are considered. In case your credit score is less than desirable, your loan may be sanctioned but at a higher rate of interest.
Banks and financial institutions are always the extra careful bit. So you end up with a loan of 75-80% of the property value. The applicant brings in the rest of the amount. If you can pay a higher down payment, total EMIs and the rate of interest comes down.
Do you notice the interplay of interest rates in every aspect of your home loan?
Home loan and interest rates
We all understand what interest means in financial parlance.
Interest rates on all kind of loans are a function of economic conditions in the country.
Inflation, money supply, global economic conditions are some of the factors that affect interest rates. The Reserve Bank of India (RBI) uses various tools like the Repo Rate, Cash Reserve Ratio, and Statutory Liquidity Ratio to regulate interest rates in the economy.
The repo rate is the rate at which banks borrow from RBI. It sets the tone for all other interest rates.
Since April 2016, the RBI has introduced a new benchmark called the Marginal Cost of Fund Based Lending Rate (MCLR). It aims to bring in transparency in interest rates. It also ensures better transmission of cut in interest rates. All home loans sanctioned post-April 2016 are linked to MCLR. Banks add a spread over and above the MLCR which forms the final lending rate. Home loans linked to MLCR are reset every six months or in a year.
For example: Let us say you avail a loan on yearly reset basis in Sep 2017 and the RBI cuts repo rate in October 2017. Even though banks MCLR comes down in the same month, the effect of it for the borrower will be seen in Sep 2018 only.
So it pays to have some information on the interest rate cycle before agreeing for a shorter or longer duration reset of MLCR.
If you have loans linked to the earlier Base Rate, one could move it to MLCR, often with some charges.
You should keep in mind that only banks are subject to lending rates linked to MLCR. But if you decide to borrow from financial institutions/housing finance companies, they set their own interest rates.
Floating or fixed rate of interest?
During the base rate regime, fixed rates or floating rates mattered depending upon the interest rate cycles in the economy. Fixed rates remained fixed for the tenure of the loan, and floating rates moved with changes in the Base Rate.
But, with the introduction of MLCR, these terms have lost their significance. Now what matters is the reset period. As explained above, interest rates will be reset only at the end of a stipulated period. So in the scenario of rising interest rates, it is beneficial to have a longer reset period. And the opposite holds good for falling interest rates.
Under MCLR, interest rates vary according to the amount applied for, the tenure of the loan and your risk grade as classified by the bank. Banks are quite transparent, and the entire list is available for reference on their websites.
Whatever be the amount and tenure, it is always helpful if you can make partial prepayments during the tenure of the loan so that your overall interest cost on the loan comes down.