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Fixed Rates: Should You Bite The Bait?

By Vishesh Sharma | 9/26/2011 4:28 PM Monday

Almost everybody had expected the RBI to take a pause in hiking key interest rates. However, these expectations have been dealt a cruel blow. The central bank dashed all hopes of a respite, by increasing the rates by 25 basis points yet again, in what was the 12th hike since March 2010. While there is again an expectation building up that this will be the last hike before interest rates begin to go down, the future course of the RBI would actually depend on the ever-pervasive phenomenon of inflation. After all, hasn’t controlling inflation been the sole purpose of the RBI in raising interest rates over the past year or so? While inflations and interest rate hikes are subjects of high finance, these economic events do not fail to touch the common man in one way or the other. One interesting phenomenon that is emerging out of all this drama of higher interest rates and inflationary pressures is the smart marketing strategy of financial institutions, which have now started selling dual-rate loans aggressively.

Banks Playing Smart
Since interest rates in India are appearing to have peaked, financial institutions are rushing in with dual-rate housing loans, hoping to tie-up prospective borrowers at peak rates of interest for a few years more. ICICI Bank first set this ball rolling, by launching home loans with the option of a fixed rate for either the first year or for the first two years. The fixed rate for one year is between 10.5 per cent and 11.5 per cent, depending on the loan amount, and between 10.75 per cent to 11.75 per cent for two years. HDFC Bank followed suit, by unveiling products with fixed as well as floating rates packaged into one loan offer – the plans offer fixed rates for the first three (between 10.75 per cent to 11.75 per cent) or five years (between 11.25 per cent to 11.75 per cent). LIC Housing Finance, too, has joined the game, with its ‘New Advantage 5’ scheme. This product offers a fixed rate of interest for the first five years, and a floating rate thereafter, with an interest rate in the range of 11.15 per cent to 11.65 per cent. Another financial institution, Edelweiss Housing Finance, has also launched two-year and five-year fixed rate loans.

Dual Rates: Comforting or Cunning?
The fixed-floating rate combination gives borrowers, particularly young home buyers, a degree of comfort in the crucial initial years of the loan, when their borrowing capacity is stretched, and they cannot afford too much elasticity in their monthly outgo. For instance, as the average age of home buyers has come down, a typical borrower could very well be in the early stages of his/her career, when he/she takes the decision to purchase the first house. In such a scenario, the individual may borrow from multiple sources, including friends and parents, apart from dipping into personal savings, to make up the margin money. The remaining balance would be financed by the home loan. It is at this crucial stage that the EMIs become critical, and a borrower can ill afford uncertainty in interest rates. Products with a fixed interest rate in the initial years prove useful to this market segment. On the basis of market feedback, the tenure of fixed rates has been increased to as long as three years and five years. This means that by the time borrowers are exposed to the market interest rates, they are well-settled into their jobs, are likely to have benefited from some salary hikes and are able to absorb potential hikes in interest rates.

 

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