Last Sunday I ransacked my cupboard in search of some papers. Though I could not find what I was looking for, what I stumbled upon was the loan sanctioning letter from the bank from where I had taken my home loan in 1998. Nostalgia engulfed me as I glanced through the letter, and was also surprised to see the rate of interest I was charged for my loan of Rs.2.50 lakh. It was 18.75 per cent.
Being a financial planner, curiosity prompted me to search my cupboard further to find the loan sanctioning letter from another HFC from where I had got my second loan to construct the first floor in 2006. I found that letter too and saw that the rate of interest charged was nine per cent. In eight years the rate of interest had more than halved!
I just thought: would it have been better if I had opted for a floating rate in 1998 and saved my EMI outflow? It is another matter that in the 90s anyone hardly knew about the floating rate concept and the borrower & lender never discussed such issues and it was a fixed rate loan by default.
By 2006, perhaps I had become an “intellectual” and thinking the rate of interest would fall further, I had opted for a floating rate. Unfortunately my so-called intellectual thinking seemed to have backfired. My EMI outflow has increased considerably over the last 18 months and now I am paying more each month for the same loan amount, putting my monthly budget into complete disarray.
Clueless
Most of the people whom I meet in the course of my advising ask me that dreaded question – should they go for floating rate or fixed rate? I am scared to answer that question given the current economic situation because I am as clueless as the RBI Governor in predicting the future course of interest rates of this country. Over the last few weeks there were some positive macroeconomic indicators that the interest rates would ease backed by moderation in inflationary trends and by the end of this fiscal there was some respite expected. But the rupee depreciation has spoiled the party.
What we should note is that the usual repayment schedule on housing loans is over 10 years and can stretch up to 20 years or more in certain cases. These many years are quite long and interest rate fluctuations can neither be predicted nor controlled.
The problem happens at lower interest rates. For example, when we get a loan at eight or nine per cent the economic indicators lead us to an understanding that the interest rates could fall in the short to medium term, which prompts us to choose floating rate instead of fixed rate. We make the mistake of expecting the interest rates to fall to five or four per cent over the future years and that it could help in reducing our EMIs. I feel this understanding itself is wrong because when the interest rates are already at eight or nine per cent and when India is still a long way away from various reforms to take it to the next level of being an economically developed country, inflation and interest rates are difficult to control and the rates could remain high for longer than one can persist.
The logic
At the current rate of interest which is in the range of 11 to 14 per cent (depending upon the loan value and the tenure of repayment), it makes sense to choose the floating rate. The logic is again the lengthy loan repayment schedule. It might take longer than expected for the government to control the inflationary trends, but sooner or later the situation would ease which can bring down the interest rates to below 10 or nine per cent. One needs to display patience and wait for things to unfold on this front.
It is all a mindset. It is like saying “everyone wants to go to heaven, but nobody wants to die.” We all want to get loans and be happy to live in our own houses but we do not want to be part of the interest rate fluctuations. The dilemma whether to choose floating rate or fixed rate will continue and this predicament will make us to choose fixed rate at higher rate of interest and floating rate at lower rate of interest. But whatever we choose, we should choose wisely because if at eight per cent we expect the rate to go down to five per cent in the future, at 11 per cent we expect the rates to go up to 15 per cent.
But speaking without being blindfolded, interest rates cannot rise to such monstrous levels, because the effect of such rise is not only about lending rates but also about other aspects which this column cannot explore. The effect on the economy will be inexplicable. So, take a floating rate confidently. And don't quote me if the government cannot do anything and persists with a high interest rate.
(The author is professor in wealth management/ financial planning, and advisor on investing habits, and can be contacted at balajiraodg@gmail.com)
