Lotus India Asset Management company has recently launched a so called quant based mutual fund that is aimed at investing in such a fashion that it will eliminate human errors and select the stocks based on a computer generated algorithm.
I liked the punch-line “Eliminate Human Error” and depend upon computer algorithms for stock selection and portfolio churnings.
At last, there is one such fund house that agrees that fund management can contain human errors. Should it mean that other previous funds from Lotus AMC (and other fund houses), are not worth the investor’s trust, as they may be full of human errors?
The fund has the standard rate as per other funds – 2.25% at entry load, 1%, 0.6% and Nil exit load based upon the time you exit after remaining invested in the fund.
As per the details:
Lotus India Asset Management Company Monday launched Quant based scheme, Lotus India AGILE Fund (Alpha Generated from Industry Leaders Fund).
Quant funds operate on the basis of computer generated mathematical models. The investment objective is to generate capital appreciation by investing in a passive portfolio of stocks selected from the industry leaders on the basis of a mathematical model.
The new fund offer priced at Rs 10 per unit.
The fund will invest 90-100 per cent in equity and equity related instruments and 0-10 per cent in debt and money market instruments.
The fund offers two options--Growth and Dividend. The Dividend option offers Dividend Payout and Dividend Re-investment facilities.
Lotus India Agile Fund is an open ended equity scheme that will invest in 11 stocks (9 per cent each) determined by a mathematical model. The portfolio will be reviewed and reset every month.
The fund wants to limit itself to only 11 stocks. Can the algorithm be efficient enough to select the best performing 11 stocks always?
If the fund is so good and (human) error free, then why are there entry and exit loads as any other standard fund? Can the AMC give any guarantee of even 1% returns?
Can a computer really work better in predicting stock prices for the future? Elderly people are now going to cyber-cafes to match the horoscopes of their child with those of their prospective life-partners. All that happens is that crap software like “Kundli” uses stored information and matches the horoscope. Hardly anyone will understand anything, yet the elderly, without having any basic knowledge about a computer, will be happy to use it to match horoscopes.
Even if someone designs an algorithm to predict future stock prices, it all has to be based upon historical data and publicly available market information. Nothing better than a computer matching horoscopes.
No quantitative model can work efficiently ever after to pick up the stock market winners month after month consistently.
This fund is nothing but “Old Wine in a New Bottle”. Same old fund management charges, same old stock selection tricks disguised in the name of quantitative models.
Investors may try their luck by betting!
Thursday, 29 November 2007
Tuesday, 27 November 2007
Pension fund money enters Equity markets
PFRDA, Pension fund Regulatory and Development Authority, has finally paved the way for a new and much awaited pension scheme, through which the pension fund money can now be invested in the share markets, as per the will and wish of the employee.
SBI, UTI and LIC have been appointed as the Fund Managers for this scheme.
However, initially it will be only the central government employee, a bit more than 3 lakhs in numbers, who will have the option of this scheme. It is expected that 20 billion Rs. will be made available to this scheme by June 2008, which is when this scheme will finally be rolled out.
19 states have accepted to implement this policy, except the states of Left controlled states of West Bengal, Tripura and Kerala.
Initially, the government will be bearing the cost of account and fund management charges, which may later be shifted to the individual as things proceed. There is still no certainty about when will the same scheme be made available to the rest of the pension fund holders, (like EPF contributors working for private organizations). So for the time being, such individuals have to depend upon private retirement plans offered by private banks and fund houses.
The move was much awaited, atleast the developments have taken place.
Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
SBI, UTI and LIC have been appointed as the Fund Managers for this scheme.
However, initially it will be only the central government employee, a bit more than 3 lakhs in numbers, who will have the option of this scheme. It is expected that 20 billion Rs. will be made available to this scheme by June 2008, which is when this scheme will finally be rolled out.
19 states have accepted to implement this policy, except the states of Left controlled states of West Bengal, Tripura and Kerala.
Initially, the government will be bearing the cost of account and fund management charges, which may later be shifted to the individual as things proceed. There is still no certainty about when will the same scheme be made available to the rest of the pension fund holders, (like EPF contributors working for private organizations). So for the time being, such individuals have to depend upon private retirement plans offered by private banks and fund houses.
The move was much awaited, atleast the developments have taken place.
Link to previous article : Investments, Earnings and Living
Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Investments, Earnings and Living
Some information about a recently conducted survey by Economics Research Department of Indicus Analytics:
India is a land of diversities
The same goes true with the business and economic perspective. As per the research conducted by the Economics Research Department of Indicus Analytics, not a single city in India is having worth of offering all the 3 basic necessities together: Earnings, Investments and Living.
For e.g., Gurgaon near NCR, is good for earning money because of the MNCs available there, but is not worth investing and living due to very-very high cost of living.
Here is the brief summary of the survey:
Cities worth Earning: Gurgaon, Silvasa, Noida, Faridabad, Roopnagar, Chandigarh, Bangalore, Pune, Surat
Cities worth Investment: Silvasa, Coimbatore, Ludhiana, Shimla, Gandhinagar, Surat, Itanagar, Chandigarh
Cities worth Living: Cochin, Kozhikode, Shimla, Thiruvanathapuram, Mysore, Goa, Thrissur, Pondicherry, Konnur, Thiruvallur. Interestingly, 5 cities in this list are from Kerala alone. North India has only one city Shimla. No major IT city is worth living, as per this research - Not even any of the 4 metros in India.
Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
India is a land of diversities
The same goes true with the business and economic perspective. As per the research conducted by the Economics Research Department of Indicus Analytics, not a single city in India is having worth of offering all the 3 basic necessities together: Earnings, Investments and Living.
For e.g., Gurgaon near NCR, is good for earning money because of the MNCs available there, but is not worth investing and living due to very-very high cost of living.
Here is the brief summary of the survey:
Cities worth Earning: Gurgaon, Silvasa, Noida, Faridabad, Roopnagar, Chandigarh, Bangalore, Pune, Surat
Cities worth Investment: Silvasa, Coimbatore, Ludhiana, Shimla, Gandhinagar, Surat, Itanagar, Chandigarh
Cities worth Living: Cochin, Kozhikode, Shimla, Thiruvanathapuram, Mysore, Goa, Thrissur, Pondicherry, Konnur, Thiruvallur. Interestingly, 5 cities in this list are from Kerala alone. North India has only one city Shimla. No major IT city is worth living, as per this research - Not even any of the 4 metros in India.
Link to previous article : Buy a home on loan or rent?
Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Monday, 26 November 2007
Buy a home on loan or rent?-1
This is the question that concerns majority of the people who have relocated to other cities following a job or business requirement – Should I buy the house NOW by taking a loan OR should I wait for some more time for the real estate prices to come down and interest rates to stabilize?
You will find different answers from different people whom you ask this question.
Call up the bank and home loan officer – his response – “We have excellent discounts available, the interest rates are just right to take a loan – in future it may appreciate further. Let me know your details and I’ll visit you and explain”
Call up the realtors selling apartments – their response – “Only 2 flats are left in this building, rest all are booked and this is the most upcoming and happening areas which will only appreciate in value. If you miss it now, it will become costlier day by day and unavailable”
Ask you friend who has already taken a house loan – “You MUST take a house loan as soon as possible. See, I took loan 1 year back. I got the possession 2 months back and the price of my house has increased to 1.5 times in just one year. There can be no better investment than house and house loan. So just go ahead and invest.”
Ask your friend who has NOT taken a house loan and is staying in rented apartment – “Yaar, rented apartment is the best. No long term commitment and freedom to relocate to any place and in any city. God knows how long can I keep up my job.”
Another friend who has bought a piece of land or plot – “Forget about house, a house depreciates in value. Some day or the other the fall will come in real estate. Land only appreciates in value, irrespective of the market situation. So invest in land, and later sell it at much-much higher price to buy apartment.”
Basically, all you will hear is the psychological biases of individuals trying to justify what they have done. Hardly anyone will know anything about the markets – all have taken random shots for their financial commitments and will be ready to shout at the top of their voice to claim that what they did was correct and you should soon follow them by taking their valuable advice.
Now, many-many articles are available on site like rediff, citing extreme end examples of people who should take loans and people who should not take loans. However, a general dilemma can never go away.
Unfortunately, no one can tell what you should do. It is you who has to take the call. It is you who will be responsible for your financial obligations if things go wrong and you get into a financial distress. Hence, take advice from others, but take decisions on your own.
As a finance professional, I know one thing for sure: No markets, No Industry, No country can continue to grow consistently with even a double digit growth. People who claim to make claims of even a mediocre 20% profit from their stock picking skills are again reminded of how the overall market has performed.
Now forget about the stock market and its overall fantastic returns. All of you must have already heard the “Indian Growth Rate ranging from 8% to 10%”. If it is so easy to make money, why is the government, the country still struggling to keep up the growth rate at mere 9% (not even touching the smallest double digit figure of 10%)?
The reason is same as cited above. Overall, the profits from one segment are nullified (to a major extent) by the losses in another segment. A high salary requires relocation, and the cost of living eats up majority of salary. If you can make and save more – you are just lucky.
So coming back to the real estate market – there has to be a saturation level –atleast in terms of the price rise. If today, the house prices are rising with annual 20-50% range, then there will definitely be a time when the prices will either fall nosedive, if the MNC start laying off people (the major customers of real-estate boom) OR atleast there will be a time when the price rise will be limited in a single digit range. When will it happen? No one knows. But my finance knowledge and historical data is sufficient to convince me for this.
Continue to Part II
You will find different answers from different people whom you ask this question.
Call up the bank and home loan officer – his response – “We have excellent discounts available, the interest rates are just right to take a loan – in future it may appreciate further. Let me know your details and I’ll visit you and explain”
Call up the realtors selling apartments – their response – “Only 2 flats are left in this building, rest all are booked and this is the most upcoming and happening areas which will only appreciate in value. If you miss it now, it will become costlier day by day and unavailable”
Ask you friend who has already taken a house loan – “You MUST take a house loan as soon as possible. See, I took loan 1 year back. I got the possession 2 months back and the price of my house has increased to 1.5 times in just one year. There can be no better investment than house and house loan. So just go ahead and invest.”
Ask your friend who has NOT taken a house loan and is staying in rented apartment – “Yaar, rented apartment is the best. No long term commitment and freedom to relocate to any place and in any city. God knows how long can I keep up my job.”
Another friend who has bought a piece of land or plot – “Forget about house, a house depreciates in value. Some day or the other the fall will come in real estate. Land only appreciates in value, irrespective of the market situation. So invest in land, and later sell it at much-much higher price to buy apartment.”
Basically, all you will hear is the psychological biases of individuals trying to justify what they have done. Hardly anyone will know anything about the markets – all have taken random shots for their financial commitments and will be ready to shout at the top of their voice to claim that what they did was correct and you should soon follow them by taking their valuable advice.
Now, many-many articles are available on site like rediff, citing extreme end examples of people who should take loans and people who should not take loans. However, a general dilemma can never go away.
Unfortunately, no one can tell what you should do. It is you who has to take the call. It is you who will be responsible for your financial obligations if things go wrong and you get into a financial distress. Hence, take advice from others, but take decisions on your own.
As a finance professional, I know one thing for sure: No markets, No Industry, No country can continue to grow consistently with even a double digit growth. People who claim to make claims of even a mediocre 20% profit from their stock picking skills are again reminded of how the overall market has performed.
Now forget about the stock market and its overall fantastic returns. All of you must have already heard the “Indian Growth Rate ranging from 8% to 10%”. If it is so easy to make money, why is the government, the country still struggling to keep up the growth rate at mere 9% (not even touching the smallest double digit figure of 10%)?
The reason is same as cited above. Overall, the profits from one segment are nullified (to a major extent) by the losses in another segment. A high salary requires relocation, and the cost of living eats up majority of salary. If you can make and save more – you are just lucky.
So coming back to the real estate market – there has to be a saturation level –atleast in terms of the price rise. If today, the house prices are rising with annual 20-50% range, then there will definitely be a time when the prices will either fall nosedive, if the MNC start laying off people (the major customers of real-estate boom) OR atleast there will be a time when the price rise will be limited in a single digit range. When will it happen? No one knows. But my finance knowledge and historical data is sufficient to convince me for this.
Continue to Part II
Buy a home on loan or rent?-2
This is part II of the article Buy a home on loan or rent?. Please read the first part before proceeding with this one
So unfortunately, the dilemma continues. But just take an example as cited in my previous article. You decide to buy a flat costing 40 lakhs. You get 32 lakhs as loan from the bank. Rest 8 lakhs you put in from your own kitty. The EMI typically comes to around 30,000 per month for 20 years. So for 32 lakhs loan, you return to the bank an amount = 30 K * 12 months * 20 years = 72 lakhs.
This amount is double the amount of money you are taking from the bank as house loan.
Off course this has to be repayed over a long duration of 20 years so DCF analysis will lead to a lower amount, but this figure tells you the cost of loan. But is it really worth taking a loan when the bank is earning more than double the amount from you? More so, in the world which is full of uncertainties – about your job, your salary and everything else?
Also, don’t forget that 8 lakhs you are paying from your pocket. Ultimately, if everything goes well for 20 long years – one fine day you will become the real proud owner of your house, maybe when you reach in your forties or approaching 50. During these 20 years, you would have lived with either of the two:
• A bit worried look about job and salary uncertainty – due to your home loan commitment OR
• An ignorant belief and worry less life if you want to keep yourself ignorant about your home loan & your uncertainties
To me, majority of (sane) persons would be forced to live with option 1. Add to it the increase in cost of living due to marriage, kids, their education, elderly parents (their medical care) and so on, and things will keep looking difficult (may not be difficult in reality, but due to the commitments).
Ultimately, it all depends upon the individual – how he takes it. People will have all kinds of flashy words & phrases – “Positive outlook towards life”, “Taking up the Challenge”, “Doing something on my own” and so on, the fact is that in case of a financial distress (if it occurs), you will be left all alone. The same friends who advice you will no longer be willing to see you and you will have to face the situation on your own.
Take a step forward:
Instead of taking the house on loan now, go for a rented one for a period of say 10 years. In an IT city like Hyderabad, a typical 2 BHK flat would cost 8 to 10 K per month. Assume that you start with 9K and your house rent increase each year by 10%. So overall, during these 10 years, you would pay to different house-owners a total of 17.2 lakh Rs. (Round it to 18 Laks)
On the other hand, during the same 10 year period, if you had taken a housing loan, you would have repaid to the bank half of 72 lakhs – i.e. 36 lakhs and 8 lakhs upfront from your kitty = total 44 lakhs. Of course you would have become part owner of your house in this case.
So, in case of renting the apartment, you save 44 – 18 = 26 Lakhs as compared to buying one on loan.
Even if the real-estate prices keep on increasing at a rate of 8% each year, the house costing 40 lakhs today will cost 80 lakhs after 10 years.
So think about buying the house then. Will it be a better option? Let’s see:
• During these 10 years – you’ve lived freely – no commitment – no worries
• If you loose your job, you pack up your bags and go back to your native town.
• If you are still able to keep up your job for 10 years – that means you are worth it. However low, you can still expect atleast a 5% salary hike each year. That will add to your accumulated savings, which will severely reduce your loan amount.
• You can take decision on “Take things as they come” basis
• Your rent savings will be more, if instead of paying an increased rent, you opt to move to another apartment of same rent or low rent.
• You don’t have to worry about any kinds of problems that may be linked to a house purchase and its later consequences as mentioned about the risks with a house purchase in this article
• If the reality markets go for a correction, you will have the option of buying the similar flats with cheaper price levels – anytime during the 10 year period – meaning more savings in future than present day high price purchase
• In the 10 year period, you may move around 3 time to 3 different houses. It’s not that difficult to find a house on rent
Nothing in this world comes without risks and compromises:
• You will have to keep moving to other apartments if the rented house or house owner is not good (Independence for some, problems for others)
• You will have to think carefully about your family (if married) and plan your family developments
• People usually do not appreciate a family man living in rented apartments for long. One may have to face it. However, the benefits of postponing the purchase can be a major beneficiary
Ultimately, the choice is yours. You have to fight against the variations in the markets. You have to take the decisions on till when to rent and when to buy. If buying then is the market really low or can it go down further.
I may have missed some points in the calculations above. Some assumptions may be faulty. However, the essence that I want to convey is that just don’t forget that loan is very-very costly. Avoid it as much as possible. The mental tension that one gets once he’s in debt cannot be explained. His negotiation power reduces, he cannot switch job and move to another city easily, he starts worrying about the job, its’ security, the family, kids and very simple liabilities add up.
Hence, take the minimum possible loan. Live a happy and stress free life. Use your own money. Leave the OPM concept to banks and brokers (OPM – Other people’s money –like the business of MF managers, brokers, etc.) OPM is not for people without financial background.
So unfortunately, the dilemma continues. But just take an example as cited in my previous article. You decide to buy a flat costing 40 lakhs. You get 32 lakhs as loan from the bank. Rest 8 lakhs you put in from your own kitty. The EMI typically comes to around 30,000 per month for 20 years. So for 32 lakhs loan, you return to the bank an amount = 30 K * 12 months * 20 years = 72 lakhs.
This amount is double the amount of money you are taking from the bank as house loan.
Off course this has to be repayed over a long duration of 20 years so DCF analysis will lead to a lower amount, but this figure tells you the cost of loan. But is it really worth taking a loan when the bank is earning more than double the amount from you? More so, in the world which is full of uncertainties – about your job, your salary and everything else?
Also, don’t forget that 8 lakhs you are paying from your pocket. Ultimately, if everything goes well for 20 long years – one fine day you will become the real proud owner of your house, maybe when you reach in your forties or approaching 50. During these 20 years, you would have lived with either of the two:
• A bit worried look about job and salary uncertainty – due to your home loan commitment OR
• An ignorant belief and worry less life if you want to keep yourself ignorant about your home loan & your uncertainties
To me, majority of (sane) persons would be forced to live with option 1. Add to it the increase in cost of living due to marriage, kids, their education, elderly parents (their medical care) and so on, and things will keep looking difficult (may not be difficult in reality, but due to the commitments).
Ultimately, it all depends upon the individual – how he takes it. People will have all kinds of flashy words & phrases – “Positive outlook towards life”, “Taking up the Challenge”, “Doing something on my own” and so on, the fact is that in case of a financial distress (if it occurs), you will be left all alone. The same friends who advice you will no longer be willing to see you and you will have to face the situation on your own.
Take a step forward:
Instead of taking the house on loan now, go for a rented one for a period of say 10 years. In an IT city like Hyderabad, a typical 2 BHK flat would cost 8 to 10 K per month. Assume that you start with 9K and your house rent increase each year by 10%. So overall, during these 10 years, you would pay to different house-owners a total of 17.2 lakh Rs. (Round it to 18 Laks)
On the other hand, during the same 10 year period, if you had taken a housing loan, you would have repaid to the bank half of 72 lakhs – i.e. 36 lakhs and 8 lakhs upfront from your kitty = total 44 lakhs. Of course you would have become part owner of your house in this case.
So, in case of renting the apartment, you save 44 – 18 = 26 Lakhs as compared to buying one on loan.
Even if the real-estate prices keep on increasing at a rate of 8% each year, the house costing 40 lakhs today will cost 80 lakhs after 10 years.
So think about buying the house then. Will it be a better option? Let’s see:
• During these 10 years – you’ve lived freely – no commitment – no worries
• If you loose your job, you pack up your bags and go back to your native town.
• If you are still able to keep up your job for 10 years – that means you are worth it. However low, you can still expect atleast a 5% salary hike each year. That will add to your accumulated savings, which will severely reduce your loan amount.
• You can take decision on “Take things as they come” basis
• Your rent savings will be more, if instead of paying an increased rent, you opt to move to another apartment of same rent or low rent.
• You don’t have to worry about any kinds of problems that may be linked to a house purchase and its later consequences as mentioned about the risks with a house purchase in this article
• If the reality markets go for a correction, you will have the option of buying the similar flats with cheaper price levels – anytime during the 10 year period – meaning more savings in future than present day high price purchase
• In the 10 year period, you may move around 3 time to 3 different houses. It’s not that difficult to find a house on rent
Nothing in this world comes without risks and compromises:
• You will have to keep moving to other apartments if the rented house or house owner is not good (Independence for some, problems for others)
• You will have to think carefully about your family (if married) and plan your family developments
• People usually do not appreciate a family man living in rented apartments for long. One may have to face it. However, the benefits of postponing the purchase can be a major beneficiary
Ultimately, the choice is yours. You have to fight against the variations in the markets. You have to take the decisions on till when to rent and when to buy. If buying then is the market really low or can it go down further.
I may have missed some points in the calculations above. Some assumptions may be faulty. However, the essence that I want to convey is that just don’t forget that loan is very-very costly. Avoid it as much as possible. The mental tension that one gets once he’s in debt cannot be explained. His negotiation power reduces, he cannot switch job and move to another city easily, he starts worrying about the job, its’ security, the family, kids and very simple liabilities add up.
Hence, take the minimum possible loan. Live a happy and stress free life. Use your own money. Leave the OPM concept to banks and brokers (OPM – Other people’s money –like the business of MF managers, brokers, etc.) OPM is not for people without financial background.
Sunday, 25 November 2007
Remortgaging: Moving to another home loan plan-1
As some of my colleagues are trapped in with floating rate home loan, I’m sure some of you may have had similar experiences.
In my previous article on house loan: fixed v/s floating, it appeared as if the readers have got the impression that I am for fixed home loan only. It’s not the case. As rmathew and nickp2 have rightly pointed out in the comments on my previous post, , that even if the interest rates are lower and you take fixed rate home loan, there is no such guarantee that the bank will not change the rates later. There may be a clause in the loan agreement, even with fixed interest rates, that banks may raise the fixed interest rates if the market situations change drastically. So ultimately, the loan borrower is in a fix, either this way or that way.
Take this practical situation:
Let’s say the loan are available for cheap i.e. the interest rates are low. A fixed rate home loan is available for 7% while a floating rate home loan is available at 6.5%. Why is fixed rate 0.5% higher than floating? The reason is that in fixed rate, the risk, to a certain extent, is passed on to the bank. In case of floating home loan, even with the slightest of rate changes, the bank will immediately change the rate for the floating rate borrower. But for fixed rate borrowers, they usually do it when there is a significant change in the interest rates. Like 7% in 2003 and now 12% in 2007. Hence, when one takes fixed rate home loan, he has to pay for the risk – ultimately, the bank is passing on the risk to the customer of fixed rate loan, by charging a higher interest rate as compared to the floating rate loan.
To understand it clearly, have a look at the interest rate offered on fixed deposits of one of the Indian banks:
In general, people believe that the longer the duration of your deposited money, the better interest rates will be offered by the bank. It is true to a certain extent, because the longer the duration of your deposit, the more time your money lies with the bank, the more time bank will have to use your money and earn profit and hence it can offer you more percentage returns in terms of higher interest rates.
However, banks cannot simply keep on giving higher interest rates depending upon the length of the deposit duration. The reason is that banks are also taking a risk by promising you a return. Suppose today, the banks promise you 12% return on 5 year long deposit and you deposit 1 million with the bank. However, in the 3rd year, the interest rate fall to the level of mere 4%, then the bank will be at a big loss if it continues to give you 12% returns. Hence, the banks have to cover this risk.
Have a look at the table above. As it can be seen, starting from 7 days to 1 year deposit period, the bank interest rates are growing consistently – from 0% to 9.5%. However, from 2 year it again starts to dip. For 2 years it is 9%, while for more it is down to 8%. This is a practical example of how the banks limit their long term interest rate risks.
Though difficult, to a certain extent it is possible to define certain ranges for interest rates for upto a year, as interest rates do not change everyday (like stock prices do). But forecasting beyond that, it becomes difficult. Hence, the interest rates offered for long term than 1 year is low compared to what is offered for upto 1 year.
Continue to Part II
In my previous article on house loan: fixed v/s floating, it appeared as if the readers have got the impression that I am for fixed home loan only. It’s not the case. As rmathew and nickp2 have rightly pointed out in the comments on my previous post, , that even if the interest rates are lower and you take fixed rate home loan, there is no such guarantee that the bank will not change the rates later. There may be a clause in the loan agreement, even with fixed interest rates, that banks may raise the fixed interest rates if the market situations change drastically. So ultimately, the loan borrower is in a fix, either this way or that way.
Take this practical situation:
Let’s say the loan are available for cheap i.e. the interest rates are low. A fixed rate home loan is available for 7% while a floating rate home loan is available at 6.5%. Why is fixed rate 0.5% higher than floating? The reason is that in fixed rate, the risk, to a certain extent, is passed on to the bank. In case of floating home loan, even with the slightest of rate changes, the bank will immediately change the rate for the floating rate borrower. But for fixed rate borrowers, they usually do it when there is a significant change in the interest rates. Like 7% in 2003 and now 12% in 2007. Hence, when one takes fixed rate home loan, he has to pay for the risk – ultimately, the bank is passing on the risk to the customer of fixed rate loan, by charging a higher interest rate as compared to the floating rate loan.
To understand it clearly, have a look at the interest rate offered on fixed deposits of one of the Indian banks:
| PERIOD | INTEREST RATES ON DOMESTIC DEPOSITS | |
| DEPOSITS | Interest Rate on Deposits Below Rs 15 lakhs | |
| 7 days to 14 days | 0 | |
| 15 days to 45 days | 5 | |
| 46 days to 60 days | 5.5 | |
| 61 days to less than 3 months | 5.5 | |
| 3 months to less than 4 months | 6 | |
| 4 months to less than 6 months | 6.15 | |
| 6 months to less than 9 months | 7.25 | |
| 9 months to less than 1 year | 8 | |
| 1 year to less than 2 years | 9.5 | |
| 2 year to less than 3 years | 9 | |
| 3 Years to less than 5 years | 8 | |
| 5 Years upto 10 years | 8 | |
In general, people believe that the longer the duration of your deposited money, the better interest rates will be offered by the bank. It is true to a certain extent, because the longer the duration of your deposit, the more time your money lies with the bank, the more time bank will have to use your money and earn profit and hence it can offer you more percentage returns in terms of higher interest rates.
However, banks cannot simply keep on giving higher interest rates depending upon the length of the deposit duration. The reason is that banks are also taking a risk by promising you a return. Suppose today, the banks promise you 12% return on 5 year long deposit and you deposit 1 million with the bank. However, in the 3rd year, the interest rate fall to the level of mere 4%, then the bank will be at a big loss if it continues to give you 12% returns. Hence, the banks have to cover this risk.
Have a look at the table above. As it can be seen, starting from 7 days to 1 year deposit period, the bank interest rates are growing consistently – from 0% to 9.5%. However, from 2 year it again starts to dip. For 2 years it is 9%, while for more it is down to 8%. This is a practical example of how the banks limit their long term interest rate risks.
Though difficult, to a certain extent it is possible to define certain ranges for interest rates for upto a year, as interest rates do not change everyday (like stock prices do). But forecasting beyond that, it becomes difficult. Hence, the interest rates offered for long term than 1 year is low compared to what is offered for upto 1 year.
Continue to Part II
Remortgaging: Moving to another home loan plan-2
This is part II of the article Remortgaging: Moving to another home loan plan. Please read the first part before proceeding with this one
In case of home loan fixed or floating, the banks have to deal with this interest rate variation for a much longer duration – 15, 20 25 years. This becomes a major risk for them as the amount of money at stake is also high. Therefore, when one takes a floating home loan from a bank, initially he is shown the juicy carrot of 0.5% lower interest rates than fixed and then he is ripped off his money by increasing the floating rates as soon as RBI changes rates but not reducing it when the RBI cuts the rates.
This way or that way, fixed or floating, the banks win at all fronts. The financial planning of the individuals may or may not fail – because he becomes the victim of rates variations – a victim of randomness.
But do banks simply keep on charging anything they like in the name of floating rate? No, they don’t, because the market is efficient. Suppose that you started repaying a floating home loan with 10% interest rate. But after 2 years, the bank gradually increased it to 14% owing to the market changes. However, it is offering a discount to the new customers, who are offered loans at 13.5%. What do you do?
The fact is that banks cannot simply keep on raising the interest rates as they wish. Because there is competition from other banks in the market and if rates are increased to a high level, then the customer may go for what is called Remortgaging - meaning, financing the present loan which is costing him 14%, with another bank which is offering say 13% to new customers. Hence, if you took a loan of 3 million and have an outstanding of 2.5 million, then you can save 1% by remortgaging, i.e. 1% of 25 lakhs = 25K each year. The compounded value of this 25K will be much higher.
Banks know this fact very well, hence they do not increase the floating rates randomly as per their will and wish. However, they still have a mechanism to extract money from you. If you remortgage, there are pre-payment charges typically 2%. Hence, If you are remortgaging to save the 1% (or 25K each year), then upfront you will have to pay 2% to your existing bank which will be 2% of 25 Lakhs = 50 K. Then there will be other formalities like stamp duty on new agreement, insurance of home to new bank as beneficiary (or transfer of benefit), your personal insurance, etc., etc. Ultimately, it all becomes almost null and void.
If you are getting fed up of your present bank which was good to you in the beginning and now charging you higher interest rates for EMIs, what is the guarantee that the new bank will not do the same to you after sometime?
Hence, think 10 times before selecting a plan or a loan. Be it a small personal loan or two-wheeler loan or a big long term commitment like housing loan. It is not at all advisable to be in debt irrespective of whether the interest rates are high or low – unless and until you are using the loan money for further profits. Don’t forget that this is India, where the bureaucratic system is hopeless. A complain in the consumer court takes years to resolve. House is a necessity, one needs it. But don’t base your judgement on faulty assumptions of your salary – its eternal growth and its eternal continuity.
I will agree with only 1 point mentioned in the book Billionaire in Training by Bradley J Sugars, however
A paycheck, no matter how big, cannot be defined as wealth or riches. So often people seem to mistake getting a bigger paycheck or salary for getting richer.
The biggest thing with a paycheck is that it might stop anytime, you never know, as this cute little puppy discovered after the big deal :-)
In case of home loan fixed or floating, the banks have to deal with this interest rate variation for a much longer duration – 15, 20 25 years. This becomes a major risk for them as the amount of money at stake is also high. Therefore, when one takes a floating home loan from a bank, initially he is shown the juicy carrot of 0.5% lower interest rates than fixed and then he is ripped off his money by increasing the floating rates as soon as RBI changes rates but not reducing it when the RBI cuts the rates.
This way or that way, fixed or floating, the banks win at all fronts. The financial planning of the individuals may or may not fail – because he becomes the victim of rates variations – a victim of randomness.
But do banks simply keep on charging anything they like in the name of floating rate? No, they don’t, because the market is efficient. Suppose that you started repaying a floating home loan with 10% interest rate. But after 2 years, the bank gradually increased it to 14% owing to the market changes. However, it is offering a discount to the new customers, who are offered loans at 13.5%. What do you do?
The fact is that banks cannot simply keep on raising the interest rates as they wish. Because there is competition from other banks in the market and if rates are increased to a high level, then the customer may go for what is called Remortgaging - meaning, financing the present loan which is costing him 14%, with another bank which is offering say 13% to new customers. Hence, if you took a loan of 3 million and have an outstanding of 2.5 million, then you can save 1% by remortgaging, i.e. 1% of 25 lakhs = 25K each year. The compounded value of this 25K will be much higher.
Banks know this fact very well, hence they do not increase the floating rates randomly as per their will and wish. However, they still have a mechanism to extract money from you. If you remortgage, there are pre-payment charges typically 2%. Hence, If you are remortgaging to save the 1% (or 25K each year), then upfront you will have to pay 2% to your existing bank which will be 2% of 25 Lakhs = 50 K. Then there will be other formalities like stamp duty on new agreement, insurance of home to new bank as beneficiary (or transfer of benefit), your personal insurance, etc., etc. Ultimately, it all becomes almost null and void.
If you are getting fed up of your present bank which was good to you in the beginning and now charging you higher interest rates for EMIs, what is the guarantee that the new bank will not do the same to you after sometime?
Hence, think 10 times before selecting a plan or a loan. Be it a small personal loan or two-wheeler loan or a big long term commitment like housing loan. It is not at all advisable to be in debt irrespective of whether the interest rates are high or low – unless and until you are using the loan money for further profits. Don’t forget that this is India, where the bureaucratic system is hopeless. A complain in the consumer court takes years to resolve. House is a necessity, one needs it. But don’t base your judgement on faulty assumptions of your salary – its eternal growth and its eternal continuity.
I will agree with only 1 point mentioned in the book Billionaire in Training by Bradley J Sugars, however
A paycheck, no matter how big, cannot be defined as wealth or riches. So often people seem to mistake getting a bigger paycheck or salary for getting richer.
The biggest thing with a paycheck is that it might stop anytime, you never know, as this cute little puppy discovered after the big deal :-)
Link to previous article : Home loans: Fixed or Floating Interest Rates?
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