With changing interest rates and pricey homes, here's how you can be a savvy customer.
By Padmavathi Subramanian
I live in what's arguably the city with the world's highest real-estate prices. But our Mumbai flat was too tiny—my family, I felt, deserved something better. Selling it and moving to an affordable, larger flat farther away from my downtown office, where I reach after an hour's commute, would make my life even harder. Then, in mid-2005, my next-door neighbours decided to sell their equally small flat. I bought it with a home loan from HDFC Ltd, pulled down a wall and joined the two flats to create a fairly large home.
While applying for the loan, one question troubled me. Should I choose a fixed rate of interest, or a floating rate—one that could go up or down, depending mainly on inflation? Interest rates were low in 2005. But one never knows: "low" and "high" are relative terms in the world of finance. If I chose the 7.75% fixed rate offered, and (who can tell?) it went down to 5% in a year, I'd feel sorry. On the other hand, if rates went up to 10% or more, I'd still be paying a bargain 7.75%.
I chose the fixed rate because, I reckoned, I'd always know what I'd be paying. With a floating rate, and, with an 18-year-tenure of indebtedness, I wasn't prepared for any uncertainty, even though the floating loan started at a lower rate of interest.
Looking back, the 7.75% fixed rate I chose was good for me. Because, home loan interest rates have since touched 10 to 12%. And the flat I bought in 2005 has more than doubled in value.
But not everyone's feeling so good. Those who chose floating-rate loans have got terrible surprises. In January 2007, Delhi journalist Bibhu Priyadarshi, 36, borrowed Rs14 lakhs at a floating interest rate of 9.25%; two percentage points lower than for a fixed-rate loan, a big bait. The tenure: 20 years. Today, after interest rates moved up, he has to pay an extra Rs36,000 every year. It would have been much more, had the tenure of his loan not been increased to 26 years. "The dream of owning a home has become a nightmare," says a disillusioned Priyadarshi, who will have to keep paying until he's 61 years old!
Fast-Changing Market
Meanwhile, things are changing quickly in the housing and home-loan market. In December, the government asked public sector banks to reduce interest rates for home loans of up to Rs20 lakhs. But this may only help buyers in the smaller towns, because there's a housing bubble that's pushed the price-tags on most homes in the big cities above Rs60 lakhs.
But bubbles burst. Home prices having peaked, most experts now see it as cyclical. With the current economic downturn, the main factors—job security, rising incomes, and low interest rates—that made loans easy and pushed home prices skyward have gone. Meanwhile, a lot of homes have been built or are under construction, with no buyers, all of a sudden. So real estate companies are all facing the worst of times with supply far outstripping demand. This means prices will have to come down in this year. So "wait!" says a cover story in Outlook Money magazine for that "major price correction." Prices are already falling, and most experts predict that home prices could fall by as much as 25 to 30% in 2009.
While you wait for that crash, here are some other facts you must know about home loans:
Combination loan. Home loans don't have to be just fixed or floating —the two can be combined. Here, the amount you borrow gets split into two parts: one with a fixed rate of interest; the rest floating. Why would you take the combo? The fixed rate portion helps you tide over interest rate risk. And if interest rates fall, the floating rate goes down too, and you save. Moreover, the floating portion is offered at a lower interest rate.
"Force majeure" clause, and penalties. Even with a fixed rate, the lender can decide to free itself from liability and impose a higher rate after a certain period. That may happen only in the event of unpredictably high inflation. So read all clauses in the fine print before you sign up and discuss each point with the lender.
There will also be penalty clauses. With home loans, if you're charged any penalty, try to negotiate—it may be reduced, even waived at times.
Loan against deposits. Here, you're really borrowing from your own non-liquid assets, your locked-in bank fixed deposits. When Pushpa Kumar, 43, a Chennai teacher, felt hassled by high interest rates and the paperwork involved in taking a home loan, she looked at the Rs5.25-lakh bank FD that earned her 6% interest. Pushpa took a Rs4.5-lakh loan against the FD and effectively pays just 2% interest. Moreover, she doesn't have to worry about interest-rate fluctuations.
Insurance cover. Home loans can be insured, so that the borrower's dependents are saved a lot of trouble if tragedy strikes. Ask the lender or an insurance agent about this. The insurance cover will run throughout the tenure of the loan, and if the borrower dies during that period, the insurance company must pay the rest of the loan.
Be Smart With an Existing Loan
Whether interest rates go up or down, here are things you can do with an existing home loan to save money:
Switch the loan. If interest rates go down by a few percentage points, consider switching to a reduced rate. This is much like taking a fresh loan after closing your old one. It could mean paying a small fee, but you will save. Switching could also involve changing from a fixed to a floating rate, or vice versa. Charges for converting a floating rate to a fixed one are higher than switching the other way around.
When Janki Roy,* a Mumbai executive decided to move to a bigger flat in 2002, she and her husband took a home loan together, as many working couples do. Their Rs8-lakh, 11% fixed-rate loan had a 20-year tenure. But, soon after they signed up, interest rates started to fall. In 2003, the Roys switched their loan over and got 8%. They paid a 1.5% penalty on the remaining part of the principal, which worked out to Rs12,000. But they now save Rs24,000 every year.
"Most people mistakenly think that choosing between a fixed rate and a floating rate of interest on a home loan is a one-time decision," says Harsh Roongta, CEO of Apnaloan.com. "This isn't true. But whatever decision you take, you must review it at least twice a year to study current interest rates and consider if switching makes sense. There is no one sure way of deciding what will work best for you. And there's no best time to take a loan."
Prepayment. If you suddenly run into good fortune and have spare cash, consider prepaying at least a part of your loan, at one go or maybe annually. This way, your principal will come down and your years of indebtedness will get reduced. Best of all, it will considerably cut down the total interest amount you'll pay. Many lenders, and especially the bigger ones, do not charge any penalty for up to a certain portion prepaid every year.
Bangalore graphic designer Sanjeev S. took a Rs21-lakh loan at 9% floating rate in 2006. His equated monthly instalment (EMI) worked out to Rs22,300. But in June 2007, after he earned a big amount from a major assignment, he prepaid Rs2 lakhs. But after that, his interest rate rose to 11%. The bank adjusted the Rs2-lakh prepayment against the hike in interest rate due to which neither his EMIs nor his 15-year tenure has changed so far. "But I'm always worried about what to expect next," says Sanjeev.
Refinancing. You'll find that different banks and institutions offer slightly different rates of interest. So you could take a fresh loan from one offering a lower rate and pay off your old loan. But refinancing is costlier than switching, since it will mean paying closing penalties on the first loan. But it may still be wise, if the new interest rate is substantially lower—like, say, moving from a private lender charging 12% to a public sector bank now offering 9.5%. You'll have to calculate carefully and see if your loan's tenure could also be shortened.
Timing the Market is Tough, But…
In these days of inflated home prices, a rented house may actually save you big money if you waited a while, since real-estate prices have to come down as they did, after they peaked and fell in the 1990s. Interest rates, too, are falling, after they peaked recently.
Consultants and investors at MIPIM Asia, the property trade conference in Hong Kong in late November, too, predicted tougher times ahead—for them. "We're expecting a horrible 2009," said Anshul Jain, chief executive for property services firm DTZ in India. But what's "bad" for investors and developers—the sellers—ought to be good for you, the buyer.
"We tell people to avoid trying to time the market when buying property for their own residence," says Harsh Roongta of Apnaloan. But even he suggests you "wait awhile to see if the much-awaited price correction actually happens." Even if you're buying for investment, it is best to be patient, since you must buy low and sell high during the next peak.
Meanwhile, Renu Sud Karnad, joint managing director at HDFC, says that if you're buying a home to stay in, now's the time to explore and shop around. "With sales having dropped considerably, developers would be more than willing to negotiate and give you a discount," she says. "So start looking, but remember, with home prices, one may never be able to call a correct bottom." Karnad means you're unlikely to be able to time the market and get the lowest price.
Watch Out!
Builders, too, run their business after taking loans. With the sudden economic downturn, even the biggest of builders have massive debts they're finding hard to repay now. This means you should avoid buying any unfinished house or flat, even if it is offered very cheap—what if it gets delayed for years, or never gets finished? You could lose your money. Buy only a ready home you can move into—right away.
"And never overstretch," says Renu Sud Karnad. "In the past five years, many home buyers have got carried away by the bullishness of the economy, and the low interest rates. People have borrowed money for every reason, genuine or not, and bought things beyond their needs. If they required 1000 square feet, they'd buy 1500."
So be prudent. Never borrow more than you can comfortably pay back, and never buy beyond your needs. If you take the loan while you're still young and your earnings increase substantially as the years go by, you won't feel the pinch of the EMIs after a while.
That's how I've begun to feel, three years after I took the loan. And, besides a more spacious home, there's another thing I've enjoyed. My EMIs have saved me a lot of income tax.
I live in what's arguably the city with the world's highest real-estate prices. But our Mumbai flat was too tiny—my family, I felt, deserved something better. Selling it and moving to an affordable, larger flat farther away from my downtown office, where I reach after an hour's commute, would make my life even harder. Then, in mid-2005, my next-door neighbours decided to sell their equally small flat. I bought it with a home loan from HDFC Ltd, pulled down a wall and joined the two flats to create a fairly large home.
While applying for the loan, one question troubled me. Should I choose a fixed rate of interest, or a floating rate—one that could go up or down, depending mainly on inflation? Interest rates were low in 2005. But one never knows: "low" and "high" are relative terms in the world of finance. If I chose the 7.75% fixed rate offered, and (who can tell?) it went down to 5% in a year, I'd feel sorry. On the other hand, if rates went up to 10% or more, I'd still be paying a bargain 7.75%.
I chose the fixed rate because, I reckoned, I'd always know what I'd be paying. With a floating rate, and, with an 18-year-tenure of indebtedness, I wasn't prepared for any uncertainty, even though the floating loan started at a lower rate of interest.
Looking back, the 7.75% fixed rate I chose was good for me. Because, home loan interest rates have since touched 10 to 12%. And the flat I bought in 2005 has more than doubled in value.
But not everyone's feeling so good. Those who chose floating-rate loans have got terrible surprises. In January 2007, Delhi journalist Bibhu Priyadarshi, 36, borrowed Rs14 lakhs at a floating interest rate of 9.25%; two percentage points lower than for a fixed-rate loan, a big bait. The tenure: 20 years. Today, after interest rates moved up, he has to pay an extra Rs36,000 every year. It would have been much more, had the tenure of his loan not been increased to 26 years. "The dream of owning a home has become a nightmare," says a disillusioned Priyadarshi, who will have to keep paying until he's 61 years old!
Fast-Changing Market
Meanwhile, things are changing quickly in the housing and home-loan market. In December, the government asked public sector banks to reduce interest rates for home loans of up to Rs20 lakhs. But this may only help buyers in the smaller towns, because there's a housing bubble that's pushed the price-tags on most homes in the big cities above Rs60 lakhs.
But bubbles burst. Home prices having peaked, most experts now see it as cyclical. With the current economic downturn, the main factors—job security, rising incomes, and low interest rates—that made loans easy and pushed home prices skyward have gone. Meanwhile, a lot of homes have been built or are under construction, with no buyers, all of a sudden. So real estate companies are all facing the worst of times with supply far outstripping demand. This means prices will have to come down in this year. So "wait!" says a cover story in Outlook Money magazine for that "major price correction." Prices are already falling, and most experts predict that home prices could fall by as much as 25 to 30% in 2009.
While you wait for that crash, here are some other facts you must know about home loans:
Combination loan. Home loans don't have to be just fixed or floating —the two can be combined. Here, the amount you borrow gets split into two parts: one with a fixed rate of interest; the rest floating. Why would you take the combo? The fixed rate portion helps you tide over interest rate risk. And if interest rates fall, the floating rate goes down too, and you save. Moreover, the floating portion is offered at a lower interest rate.
"Force majeure" clause, and penalties. Even with a fixed rate, the lender can decide to free itself from liability and impose a higher rate after a certain period. That may happen only in the event of unpredictably high inflation. So read all clauses in the fine print before you sign up and discuss each point with the lender.
There will also be penalty clauses. With home loans, if you're charged any penalty, try to negotiate—it may be reduced, even waived at times.
Loan against deposits. Here, you're really borrowing from your own non-liquid assets, your locked-in bank fixed deposits. When Pushpa Kumar, 43, a Chennai teacher, felt hassled by high interest rates and the paperwork involved in taking a home loan, she looked at the Rs5.25-lakh bank FD that earned her 6% interest. Pushpa took a Rs4.5-lakh loan against the FD and effectively pays just 2% interest. Moreover, she doesn't have to worry about interest-rate fluctuations.
Insurance cover. Home loans can be insured, so that the borrower's dependents are saved a lot of trouble if tragedy strikes. Ask the lender or an insurance agent about this. The insurance cover will run throughout the tenure of the loan, and if the borrower dies during that period, the insurance company must pay the rest of the loan.
Be Smart With an Existing Loan
Whether interest rates go up or down, here are things you can do with an existing home loan to save money:
Switch the loan. If interest rates go down by a few percentage points, consider switching to a reduced rate. This is much like taking a fresh loan after closing your old one. It could mean paying a small fee, but you will save. Switching could also involve changing from a fixed to a floating rate, or vice versa. Charges for converting a floating rate to a fixed one are higher than switching the other way around.
When Janki Roy,* a Mumbai executive decided to move to a bigger flat in 2002, she and her husband took a home loan together, as many working couples do. Their Rs8-lakh, 11% fixed-rate loan had a 20-year tenure. But, soon after they signed up, interest rates started to fall. In 2003, the Roys switched their loan over and got 8%. They paid a 1.5% penalty on the remaining part of the principal, which worked out to Rs12,000. But they now save Rs24,000 every year.
"Most people mistakenly think that choosing between a fixed rate and a floating rate of interest on a home loan is a one-time decision," says Harsh Roongta, CEO of Apnaloan.com. "This isn't true. But whatever decision you take, you must review it at least twice a year to study current interest rates and consider if switching makes sense. There is no one sure way of deciding what will work best for you. And there's no best time to take a loan."
Prepayment. If you suddenly run into good fortune and have spare cash, consider prepaying at least a part of your loan, at one go or maybe annually. This way, your principal will come down and your years of indebtedness will get reduced. Best of all, it will considerably cut down the total interest amount you'll pay. Many lenders, and especially the bigger ones, do not charge any penalty for up to a certain portion prepaid every year.
Bangalore graphic designer Sanjeev S. took a Rs21-lakh loan at 9% floating rate in 2006. His equated monthly instalment (EMI) worked out to Rs22,300. But in June 2007, after he earned a big amount from a major assignment, he prepaid Rs2 lakhs. But after that, his interest rate rose to 11%. The bank adjusted the Rs2-lakh prepayment against the hike in interest rate due to which neither his EMIs nor his 15-year tenure has changed so far. "But I'm always worried about what to expect next," says Sanjeev.
Refinancing. You'll find that different banks and institutions offer slightly different rates of interest. So you could take a fresh loan from one offering a lower rate and pay off your old loan. But refinancing is costlier than switching, since it will mean paying closing penalties on the first loan. But it may still be wise, if the new interest rate is substantially lower—like, say, moving from a private lender charging 12% to a public sector bank now offering 9.5%. You'll have to calculate carefully and see if your loan's tenure could also be shortened.
Timing the Market is Tough, But…
In these days of inflated home prices, a rented house may actually save you big money if you waited a while, since real-estate prices have to come down as they did, after they peaked and fell in the 1990s. Interest rates, too, are falling, after they peaked recently.
Consultants and investors at MIPIM Asia, the property trade conference in Hong Kong in late November, too, predicted tougher times ahead—for them. "We're expecting a horrible 2009," said Anshul Jain, chief executive for property services firm DTZ in India. But what's "bad" for investors and developers—the sellers—ought to be good for you, the buyer.
"We tell people to avoid trying to time the market when buying property for their own residence," says Harsh Roongta of Apnaloan. But even he suggests you "wait awhile to see if the much-awaited price correction actually happens." Even if you're buying for investment, it is best to be patient, since you must buy low and sell high during the next peak.
Meanwhile, Renu Sud Karnad, joint managing director at HDFC, says that if you're buying a home to stay in, now's the time to explore and shop around. "With sales having dropped considerably, developers would be more than willing to negotiate and give you a discount," she says. "So start looking, but remember, with home prices, one may never be able to call a correct bottom." Karnad means you're unlikely to be able to time the market and get the lowest price.
Watch Out!
Builders, too, run their business after taking loans. With the sudden economic downturn, even the biggest of builders have massive debts they're finding hard to repay now. This means you should avoid buying any unfinished house or flat, even if it is offered very cheap—what if it gets delayed for years, or never gets finished? You could lose your money. Buy only a ready home you can move into—right away.
"And never overstretch," says Renu Sud Karnad. "In the past five years, many home buyers have got carried away by the bullishness of the economy, and the low interest rates. People have borrowed money for every reason, genuine or not, and bought things beyond their needs. If they required 1000 square feet, they'd buy 1500."
So be prudent. Never borrow more than you can comfortably pay back, and never buy beyond your needs. If you take the loan while you're still young and your earnings increase substantially as the years go by, you won't feel the pinch of the EMIs after a while.
That's how I've begun to feel, three years after I took the loan. And, besides a more spacious home, there's another thing I've enjoyed. My EMIs have saved me a lot of income tax.
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