Low interest rates in the initial period of the home loan do not necessarily mean low interest outflow. In view of the prevailing home loan schemes
BAFFLED by the mumbo-jumbo of home loans when you are already lost on the choice of home? Don't want to be trapped by the gobbledygook in agreements? We ran through a host of offers made by mortgage lenders in the last few weeks, mainly from the outgo point of view over the lifetime of the loan. And it showed, the best deal for you, is from the nation's biggest, State Bank of India.
Most of the schemes discussed below offer home loans at fixed rate in initial years and switch to floating interest rate in later years, which matters the most for total interest outflow. The schemes differ from each other in terms of the spread once it become floating, prepayment charges, and in terms of other qualitative factors like the speed of processing the application, documentation requirements and time taken to disburse funds. But what matters above all is saving a few lakh rupees by paying lower interest. For the current analysis our focus is on the overall interest outflow.
THE SCHEMES:
State Bank of India offers Easy Home loan scheme under which the interest rate is fixed at 8% for first year and 8.5% for next two years for a home loan above Rs 5 lakh and upto Rs 50 lakh. Most of the public sector banks are currently offering home loan scheme on similar lines.
Till a week back it was only the PSU banks that were offering fixed rates but now, even private banks have joined the fray. HDFC, the largest housing finance company, is now offering loans where interest rate is fixed at 8.25% till Dec 31, 2012, irrespective of the loan amount.
Post 2012 this will be subject to floating rate prevailing at that time which is hard to guess even for experts. The catch is that no fixed spread is assured for the later part of the loan tenure and the time frame for making a loan application is also just about a month.
Recent entrants in this price war are ICICI Bank and Kotak Mahindra Bank. ICICI is also offering home loan at fixed rate of 8.25%. But this is for first two years and then it will be 3.5% below its prevailing Floating Reference Rate (FRR). This is applicable for loans above Rs 20 lakh and upto Rs 50 lakh. Kotak Mahindra Bank meanwhile launched fixed-to-floaty loans where interest rate is fixed at 8.49% in first 30 months (2.5 years) and floating rate thereafter, which is relatively higher compared to its peers. Nevertheless, a spread of 5.5% below PLR is assured. But since its current PLR of 14% is at a higher end amongst the group, it does not look an attractive bet. Thus not considered for the detailed analysis.
ASSUMPTIONS:
Historical trend suggests one interest rate cycle lasts for about six years. Considering this, three interest rate cycles would be witnessed over a 20-year tenure of the loan. So post the fixed interest rate regime (3 years for most schemes), we have assumed two years as buffer for the peak interest rate. Assuming rates may peak in 2012 so for HDFC it could be 15.5% from the current 13.5% (25 basis points increase in every quarter starting June'10 till March'12). Hence floating rate (FR) would be 13% for the fourth and fifth year (based on past track where FR is 2.5% less than PLR). Similarly for SBI, this would be about 10.75% for the interim two years.
Hence, sixth year onwards, we have considered these factors while arriving at the floating rate average range of 10.25-11.25% for the later part of the loan tenure. For loans above Rs 30 lakh, the interest rates charged are 50-75 basis points higher and are also subject to lower spread once the rate becomes floating.
MAKING THE CHOICE:
One should not opt for a scheme based on the rates offered in initial years. An important factor to note here is the total interest outflow over the life of the loan, although sales pitch could be on "customer service" and other subjective issues. These calculations may differ when it is done on daily reducing balance as compared to quarterly reducing balance, however broad numbers will remain the same.
For a Rs 30-lakh loan, the maximum interest outflow is Rs 42.5 lakh under HDFC's scheme as against Rs 42 lakh under ICICI's scheme. Besides ICICI, SBI's offer is the cheapest with just Rs 38.3 lakh interest outflow over 20-year period. On a monthly basis the difference in SBI and HDFC and ICICI's EMI is just Rs 468. But this is only in the first year.
As HDFC has not specified the spread in latter part of the tenure, additional EMI more than makes up for the initial lower interest rate. Though ICICI comes little lesser than HDFC, if you include the implicit cost of prepayment charges and convenience of service, the difference become insignificant.
Similarly for Rs 60-lakh loan, SBI's 'Advantage home loan' is a notch over other schemes. The next best option in this category is ICICI's dual rate product. SBI results in interest saving of Rs 3.49 lakh over ICICI scheme.
THE DECISION:
Based on the given analysis, SBI's 'Easy Home loan and Advantage Home loan' look better than other schemes in both the Rs 30 lakh and Rs 60 lakh category. Though private players are offering lower interest rate for first three years, they make up for the lost money in the later part of the loan.
So, before applying for any offer one must verify the details and not just go by absolute numbers in order to avoid agonising over the decision in the future.
