Dual Rate Home Loans – Are they better than floating rate loans?

As we mentioned elsewhere, “fixed rate” home loans are offered by banks when the interest rates are at peak or near peak and these offers dry up when interest rates come down. India Infoline, ICICI and HDFC banks have now introduced dual rate home loans and more lenders are likely to join the “rat(e) race” soon. Dual rate home loans were introduced by SBI in February 2009 as teaser rate home loans. These are also known as “Fixed first” loans. So, what are dual rate home loans? Does it benefit the lender or the borrowers?

What are dual rate home loans?

Dual rate home loan is a fixed-cum-floating rate loan that start off with 1-5 years of fixed interest rate and after this time period morph into adjustable rate home loan that keeps up with retail prime lending rate. Sometimes these fixed interest rates are set unbelievably low (and hence they are called teaser rates) and then shoot up to market rates after the honeymoon period is over. In fact, SBI was forced to pull back their teaser rates after relentless pressure from RBI. Fixed interest rates vary based on the loan amounts and loan tenure.

The dual rate home loans are offered by the lenders:

  • To prop up cooling real estate market
  • Lure in ‘fence sitting’ customers who are trying to put off their house purchase due to high interest rates
  • When they anticipate interest rates to decline and want to trap their customers into paying high interest rates
  • Competition from other lenders
  • Meet credit targets when lending slows down

Does it benefit the borrower?

Given that RBI has hiked interest rates 11 times since March 2010, the borrower might think that opting for fixed rate at least for a few years may be a good idea. Banks like to highlight benefits that allow borrowers to lock in the interest rates and cut risks of upward moving interest rates for the first few years. However, borrowers should be aware that these types of loans are generally offered when the interest rates are peaking (near 14-year high). With slower growth rate and lower inflationary pressure, the general consensus is that we may be closer to the peak of a rising rate cycle. In such cases, the borrower ends up paying higher EMI amount and not benefit from falling rates. The only advantage to the borrower is that he can be assured of fixed EMI amount in the near future and expect the EMI to change only after the fixed rate period is over. It would be wise to find the delta between the prevalent floating rate and the fixed rate being offered before choosing the appropriate home loan product.

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