Most home loans are on floating rate. While banks offer fixed and floating-rate loans, there is a reason why it happens mostly on floating rate. Earlier, in particular in 2020 and 2021, interest rates were largely on the lower side.
From the bank’s or NBFC’s perspective, there was a high probability that interest rates would rise sometime in future. As and when that happened, if the rate was fixed, the bank stood at the risk of losing margin on the loan.
Hence, banks were (and still are) showing only floating rate loans to potential customers.
High differential
The purpose is to keep the differential high. As an example, when the floating rate is 6.5 p[er cent, if the fixed rate loan is at, say 10 per cent, it is prohibitive and you are pushed to floating rate.
Thereafter, as and when interest rates rise, you pay more. Paying more happens in two ways. Either the EMI amount climbs, or loan tenure rises, or both.
Ideally, the decision should happen over a discussion with proper explanation, so that you are aware of the implications.
However, these decisions are mostly taken unilaterally and you are just informed. If you are enterprising, you would visit your loan provider, discuss/ negotiate and reset the terms. Recently, the Reserve Bank of India (RBI), the regulator of banks and NBFCs, issued guidelines on transparency during reset of floating-rate EMIs. This would not reduce the loan or EMI amount, but give you a say in the decision. Here are the guidelines and implications for you.
The text within quotes is a reproduction from the RBI notification dated August 18. The applicable date is December 31. “At the time of reset of interest rates, REs [regulated entities viz. banks/NBFCs in this case] shall provide option to the borrowers to switch over to a fixed rate.”
This depends on the differential between floating and fixed rates, and the outlook on interest-rate. Currently, fixed rates are much higher, and do not merit change from floating to fixed. If at some point of time, the differential is lower i.e. fixed rate is only a little higher, and there is a possibility of floating rate rising further, then you may mull shifting to fixed. The logic would be you are locking in a rate and doing away with the headache of it moving up further.
“The borrowers shall also be given the choice to opt for (i) enhancement in EMI or elongation of tenor or a combination of both options; and, (ii) to prepay, either in part or in full, at any point during the tenor of the loan.”
Freedom of choice
This is freedom or choice, lacking so far. While you could visit the bank/ NBFC anytime to reset the terms, in the absence of any explicit guideline, the bank could take a unilateral decision and just inform you.
If you have cash flows and can afford to prepay, it is better. You would be saving ‘interest on interest’ which is part of the EMI.
Usually, the returns you get on investments is lower than the interest rate charged on loans. If you have excess cash/ money which you can save, it is better to prepay loans. That is, enhancement in EMI is usually the better option. Or, you can do a combo: raise the EMI to the extent you can and for the balance, extend the tenure of the loan.
“All applicable charges for switching of loans from floating to fixed rate and any other service charges/ administrative costs incidental to the exercise of the above options shall be transparently disclosed”.
While charges are payable by you and are mostly non-negotiable, you may enquire if there is any scope for waiver or reduction in charges.
“REs shall ensure the elongation of tenor in case of floating-rate loan does not result in negative amortisation.” Negative amortisation means, your EMI is lower than the interest component after rate rises. In that case, since you are not even paying full interest due in the month, it goes on compounding and you can never pay back the loan.
“REs shall share/make accessible to the borrowers, a statement at the end of each quarter which shall at the minimum, enumerate the principal and interest recovered till date, EMI amount, number of EMIs left and annualised rate of interest.” This will lead to transparency and clarity.
Loan moratorium
Sometimes, flawed execution takes away the intended benefits. In 2020, during the COVID-19-induced lockdown, the RBI allowed moratorium on loans.
Some banks followed ‘opt-in’ i.e. if you do not respond to the mail within the specified date, you are opting for the moratorium.
It was not properly explained the EMI was not excused, only delayed.
By not paying in the period, you were subjected to compounding, and end up paying more over a period of time. The current notification improves transparency and empowers the customer.
(The writer is a corporate trainer and author)