Home loans: What you must know about fixed and floating interest rates - How EMIs increase and decrease

There are a host of reasons for why an individual decides to opt for home loan. These are for buying house, a flat, renovation, extension and even repairing the existing house. With policy repo rate being brought down to 6%, affordable housing loan has seen a major boost. Both banks and other financial institutions such as NBFCs and  Housing Finance Companies (HFCs) are in a stiff competition for providing best interest rates on home loan. You become eligible for home loan after a few checklists carried by banks like monthly income, credit score, assets and guarantees. It needs to be noted that, the amount of home loan is dependent upon your choice of tenure, interest rates as they determine your monthly outflow. There are also age limit criteria which need to be passed for home loans. However, it is always advisable to seek specific clarifications in regards to your home loan from a commercial bank.

Here’s what they are, as per RBI guidelines. 

Documents:

Apart from all the legal documents, banks will also ask your some identity and address proof like Aadhaar card, PAN card, passport, electricity bill and voter id. Additionally, they will also seek for latest which has to be authenticated by the employer and self-attested for employees. Also, Form 16 ( for business persons/self-employed plays major role in availing home loan. Finally, last 6 months bank statements / Balance Sheet, as applicable. Meanwhile, you will also have to submit the completed application form along with your photograph.

As per the guidelines, it is advisable to seek more information on any waivers in terms and conditions provided by the commercial bank in this regard. For instance, there are banks who insist on submission of Life Insurance Policies of the borrower / guarantor equal to the loan amount assigned in favour of the commercial bank. These are generally  amount ceilings for this condition which can also be waived by appropriate authority.

Interest rates:

There are two types of interest rates on home loan such as floating and fixed rates. 

In regards to fixed interest rates on home loan, they are unchangeable for the entire tenure of the loan or a certain part of the tenure of the loan. If you have opted for a pure fixed loan, the EMI due to the bank remains constant. If a bank offers a Loan which is fixed only for a certain period of the tenure of the loan, try to elicit information from the bank whether the rates may be raised after the period (reset clause). A customer has the privilege to negotiate a lock-in that should include the rate that you have agreed upon initially and the period the lock-in lasts. 

Meanwhile, if chosen floating interest rate they come in two parts: the index and the spread. Here, an index is a measure of interest rates generally (based on say, government securities prices), whereas the spread is an extra amount that the banker adds to cover credit risk, profit mark-up etc. Notably, the amount of the spread may differ from one lender to another, but it is usually constant over the life of the loan. 

EMIs:

EMIs aka equated monthly installments (EMIs) are a mixture of two parts namely interest rates and principal amount. EMIs are meant to be paid on monthly basis till the entire tenure of your home loan. 

If your home loan has fixed interest rates, then your EMIs are also fixed and they are known as advance. If the inflation and the interest rate in the economy move up over the years, a fixed EMI is attractively stagnant and is easier to plan for. However, if you have fixed EMI, any reduction in interest rates in the market, will not benefit you.

On the other hand, if opted for floating interest rates, the EMIs change constantly with change in market interest rates. If market rates increase, your repayment increases. When rates fall, your dues also fall.

Interestingly, according to RBI, some banks also offer their customers flexible repayment options. Here the EMIs are unequal. In step-up loans, the EMI is low initially and increases as years roll by (balloon repayment). In step-down loans, EMI is high initially and decreases as years roll by. A step-up option is convenient for borrowers who are in the beginning of their careers. Step-down loan option is useful for borrowers who are close to their retirement years and currently make good money.

Hence, before buying your dream house it is always advisable to be smart in terms of your EMIs and interest rates. Because everyone loves to pay lessor dues.