Happy New Year home buyers!

If you have plans to buy a new home in 2015, there's good news for you, says Rajiv Raj

If you have been waiting for interest rates to come down to buy your dream home, the time has finally arrived. Makar Sankranti brought in happy tidings for retail home loan borrowers as Reserve Bank of India announced a 0.25 per cent cut in repo rate, that will soon translate into cheaper home loans  and other consumer loans offered by banks.

So what kind of home loan should you consider now? Let us give you some answers.

Over the past two years, growth in the home loan market has been sluggish owing to a sluggish GDP growth, high inflation and a high cost of borrowing, all of which hit the real estate sector. Owing to the slowdown in the economy a lot of consumers who were waiting in the wings to make a property purchase put off their decision.

However, with the inflation coming down to an all time low, and an overall improvement in economic conditions, RBI finally had the headroom to cut interest rates. This move will certainly give a shot in the arm to the real estate sector and fuel hopes of home buyers as floating rate home loan products will now be available at cheaper rates.

Fixed vs floating

The question that arises is what kind of home loan should you consider, now that the rate cut cycle has finally set in and if market experts are to be believed, there will be another rate cut before the fiscal year comes to a close (before March 31, 2015). However, it is interesting to note, that over the past year, the top lenders in the country, namely SBI, HDFC, ICICI Bank and Axis Bank came out with variants of fixed interest rate home loan products. The logic stated by these lenders at that time was that they wanted to protect the consumers from the "volatility" in the interest rate cycle.

The point to be noted here is that the possibility of home loan rate cuts in the floating rate segment seem imminent as rate cuts by RBI begin to reflect on the base rate of the banks soon.

In fact, almost immediately after the rate cut announcement by RBI yesterday, some public sector lenders such as Union Bank of India and United Bank of India responded with a 0.25 per cent rate cut in their base rates bringing them down to 10 per cent. As a result, their floating rate loans become cheaper.

Note: The rate at which banks lend to their customers are linked to base rates. As base rates come down, so do lending rates. Banks cannot lend below the base rate.

The final verdict

The clear answer thus at this point of time it that, with further interest rate cuts expected over the course of the year, a fixed rate home loan does not make much sense. The other thing you should know about fixed rate loans is that they are also subject to a "reset clause" that varies from bank to bank. This means that even if you opt for a fixed rate loan you may have to cough up a higher rate of interest in case your bank makes a revision in its own lending rates.

The pre-payment charges that had been abolished by RBI is only applicable to floating rate loans of banks. Therefore, you may still be susceptible to the very volatility that lenders may claim to protect you against with a fixed home loan product. The real reason why lenders may have been wanting to push forward fixed home loan products is perhaps the fact that they wanted to lock in as many customers as possible in the fixed interest rate clause before home loan rates went down.

If you look at interest rate cycles over the past ten years, you can see that there have been no clear directions over what is going to happen to interest rates in the long term. So if you are eyeing a floating rate home loan product and were scouting for a low interest rate on it, now is the time to go in for one.

However, if you are solely concerned about the monthly outgo in terms of EMI (that you do not want to change no matter what) and are looking for a home loan for a shorter tenure of 10 years and less, a fixed home loan rate may still make sense for you. So end of the day, you must judge your own repayment capabilities, tenure of the loan and your own predictions for your financial future before you decide on a home loan product that is just right for you. 

Photograph: Todd Lappin/Wikimedia Commons

The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.