Home loan offers often vary in terms of the criteria set by the lender as well as the Reserve Bank of India (RBI) regulations prevailing at the time of your application. Without a clear understanding of how the terms of a home loan are set, you may realise at a later stage that you are paying more than you had anticipated, which may lead to misunderstandings between you and the lender. Keeping abreast of the latest financial policies and the market conditions will make your application process and loan repayment more manageable and stress-free. However, to know the basics read on.
What are the different types of home loan rates?
One of the first things you must understand about home loan offers is the type of home loan rates against which the lender is sanctioning the loan amount. These can be either fixed or floating rates.
Home loan rates offered by financial institutions are linked to the base rate or the rate below which they cannot lend, as prescribed by the RBI. The interest rate for a home loan typically comprises the base rate plus a margin, which also depends on the RBI’s directives. This is the first step towards the computation of home loan rates.
If you’re opting for a fixed home loan rate, the interest you pay on your loan will remain constant throughout the tenor. However, if you’re going for a floating rate home loan, the interest amount increases or decreases as per the market. For instance, you may have applied for a home loan at an interest rate of 10.50% three years ago. But, with the RBI increasing its rates, the rate may now be revised to 13.50%.
Floating home loan rates are less expensive than fixed, but you should only choose a floating rate if you are ready to bear the interest rate fluctuations throughout the tenor. Financial institutions review their base rates at least once every quarter, which may increase or decrease the interest you pay every few months. Fixed home loan rates, on the other hand, may be slightly more expensive, but you will be shielded from the fluctuation in the market rates.
Why does the home loan outstanding amount reduce at such a slow rate?
No matter how low or high the EMI of your home loan, you will find that a very small amount from your principal gets repaid in the first few years of your tenor. This is because the interest component on your loan is very high in the initial years.
For instance, if you have taken a loan of Rs.80 lakh for 20 years at an interest rate of 10%, your EMI will be Rs.77,202. In the first five years, you will be paying about 15% to 17% of the principal. As you proceed through the tenor, you will be slowly increasing your repayment towards the principal. Here, remember that the higher the rate of interest or tenor, the slower will be the reduction in the principal in the initial years of repayment. To get a better understanding of repayment, you can use the home loan EMI calculator that is available online. Enter the loan amount, toggle the interest rate and tenor as per the different home loan offers, and then compare the repayment structure.
Is it better to shorten the tenor or reduce the EMIs?
Whenever market corrections happen and the RBI cuts interest rates, your lender may propose small changes on your repayment terms. Restructuring or reducing the EMI can be a cumbersome process as you will have to sign a fresh Electronic Clearing Service (ECS) mandate or submit a new lot of post-dated cheques. To avoid these hassles, lenders may offer to reduce the tenor to support the restructuring.
According to experts, when the interest rate reduces, reducing the tenor will be more profitable for you. However, when the home loan rates increase, then choosing a longer tenor will increase the interest payable. So, before you sign off on any restructuring, understand the repercussions it will have on your repayment terms. Home loan is a long-term commitment and you must have all the information you need in order to make the right decision. Before allowing the lender to process your sanction, read the fine print and offer documents carefully. Clarify each point with your lender in advance and then apply for the loan. This will help you secure an affordable loan that does not surprise you with hidden charges during repayment.