Home loans: Fixed or Floating Interest Rates? – II

This is part II of the article Home loans: Fixed or Floating Interest Rates? – I. Please read the first part before proceeding with this one

Hence, the case of FIXED RATE home loan is simple and straightforward. You take x amount of money from the bank as house loan. The bank calculates your EMI based upon the then prevailing FIXED home loan interest rate and tell you how much you will be required to repay each month, for the entire duration of loan.

The problem comes with floating rate home loan, where things become ugly and unpredictable. Remember, banks offering home loans are not charitable organizations working on humanity basis – they are business organizations running for profit, and most of the loans market is dominated by private players like ICICI and HDFC banks.

Why do people take fixed rate home loans
People take fixed home loans when the interest rates are low. For example, during the 2002-2004 period, the fixed home loan rates came down to 7.5%, hence, many individuals took fixed rate home loans. Today, bank FD’s are offering as high as 9.5% returns, which is much higher than the interest these people are paying on their hme loans. Another benefit is that the borrower knows the exact amount of money he has to repay each month – so no unpredictability.

Why do people take floating rate home loans when it is unpredictable?
People take floating rate home loans when the interest rates are high – like the present situation, where the interest rates are hovering in the range of 11% to 14%. What people believe is that IF the interest rates fall, then their EMI amount will go down and hence they will benefit because they will have to repay less money to the bank. However, there is no such guarantee that the interest rates will reduce. Even if they do so, the banks may or may not reduce the home loan rates, hence, the individual will end up paying the same EMI amount.
Instead the rate may increase further and then the banks will immediately jump and increase the EMI repayment, because that will mean more profit to the bank and loss to the individual loan borrower.

How do the bank decide how and when to increase the floating rate interest?
This is the tricky part and most of the individuals get trapped in this. When you take a loan, you are asked to sign numerous times on a THICK booklet of loan agreement. The language, the conditions and other terms mentioned in this booklet – no one bothers to read it. All of us blindly sign it taking things for granted. Even if you read it, you don’t have any choice, you have to accept the T&C to take the loan. However, in essence, everything mentioned in the agreement is in favour of the bank.

Banks have something called a PLR or Prime Lending Rate. This is completely at the banks judgement. So it is possible that SBI may be having a PLR of 11% today, while ICICI may be having a PLR of 12%, while HDFC may be having PLR of 12.5%.
All the loans offered by banks are based upon this PLR. So, a two-wheeler loan offered by ICICI bank may be quoted as (PLR + 3%), which means it is available at 15%, while education loan may be offered at (PLR + 2%) = 14%.
On the other hand, SBI having a PLR of 11%, may be offering two-wheeler loan at (PLR + 2.5%) = 13.5%, while education loan for (PLR + 3.5%) = 14.5%

In summary, each bank maintains its own PLR (which can change anytime), and each bank determines different loan rates for different purposes based upon their PLR, by adding a figure to it (which again can change anytime at the discretion of the bank). So it is possible that you go to SBI to take education loan today and you are quoted 14.5%, and if you again go to the same bank after 15 days, you may be quoted 15%, because either the PLR may have changed or the additional figure may have changed in 15 days time.

Continue to Part III