Recently, I came across a borrower who had opted for ICICI Smart Fix Home loan. Under this loan product, your loan is fixed rate for a few years (3 years in this case) and thereafter becomes a floating rate loan.
Intuitively, such a loan product could be useful if you expect interest rates to go up sharply. By opting for such a product, you protect yourself against a sharp interest rate rise. Do note you do not have the protection for the entire tenure, but only for a few years. At the end of the fixed rate period, your loan will become a floating rate loan, and you will also be subject to movement in market interest rates.
For instance, you take an ICICI Smart Fix Home loan for a tenure of 20 years. The loan will be fixed rate for the first 3 years and a floating rate loan for the remainder of the tenure.
Note: This is how fixed rate home loans work in India. As I understand, there are no home loans where the interest rate is fixed for the entire tenure.
There Is No Free Lunch
The banks are not naïve and won’t give you anything for free. If you want to guard against rate hikes, albeit for a brief period, be prepared to pay a premium in the form of a slightly higher fixed interest rate.
For instance, if the floating rate loan is available at 8.5%, you may get Smart Fix (or a similar loan) at say 25 to 75 bps higher. Hence, as a borrower, you pay a premium to guard against an event that may or may not happen. OR may happen slower than you expect.
How Do You Analyse Such Products?
3 simple points.
- What is your interest rate outlook? This product can make sense if you expect interest rates to rise sharply in the coming months or years. Do note you must expect interest rates to rise sharply and quickly. If you anticipate a gradual hike, then by the time the floating rate gets to the fixed rate, you may already be towards the end of the fixed rate period.
- How much premium are you paying for the security of a fixed interest rate over the next 3 years? And is the premium worth the safety of fixed rate for just the next 3 years? After 3 years, you are going to transition to a floating rate regime.
- How does the bank transition you to a floating rate loan after 3 years? Does the bank serve you a raw deal compared to the regular floating rate borrowers? Is the credit risk spread higher compared to the regular floating rate borrowers? If that is indeed the case, then we have a problem. You will be paying more for the entire loan duration beyond the first 3 years. Clearly not wise. Yes, you do have an option to transfer your loan to another bank if you believe you are paying an extremely high rate of interest, but that’s a lot of work.
Now, there is not much information available on the lender website. Hence, I could not assess how good or bad a deal the bank is offering. However, as a prospective borrower, you must consider these points.
Should You Go for It?
Technically, such a product looks quite good if you are anticipating an interest rate hike. Since most home loans are linked to Repo rate, a rate hike by the Reserve Bank will quickly increase the interest rate for a floating rate loan.
However, forecasting interest rate movements is easier said than done. Many economists get this wrong on a regular basis. Hence, predicting the direction of interest rates is itself challenging work. So, you are making your decision about choosing a home loan product on top of an overly complex premise. Since, in this case, you are paying a premium for fixed rate for a few years, not only should you get the direction of interest rates right, but also the pace of interest rate hikes.
Fixed rate loans (or while the loan is fixed rate) may also have restrictions/penalties on prepayment and foreclosure.
I think, for most borrowers, a simple floating rate loan is a fair bet. You win some, you lose some. Alternatively, if you are very sure that interest rates will go up soon, you can opt for a fixed rate home loan product like ICICI Smart Fix.
However, even while opting for such a product, do consider the premium you are paying (during the fixed rate period and during the floating rate period).