The concept of a floating rate home loan was introduced in the country six years ago by HSBC, and since then it has caught the fancy of borrowers.

It’s not difficult to see why. At that time, interest rates were falling and home loan borrowers who had taken floating loans saved much more in terms of interest outgo than those who had locked themselves into fixed rates.

Now that interest rates are threatening to climb to double-digit figures once again, it’s time to take stock of how existing borrowers can ward off the imminent rate rise, while new borrowers can mull other options.

Who is better off?

Home loan rates have nudged up over the past 10 months by more than one percentage point. More importantly, the difference between the floating and the fixed rates for more than a 10-year loan has widened from 0.75 percentage point to 1.25 percentage points.

So, those who had taken a home loan on floating rate a few years ago, are not really worse off than those who had borrowed on a fixed rate. For example, ICICI Bank had reduced its floating rate loans four times between November 2001 — when it launched such loans — and November 2004, aggregating 175 basis points. It revised the rates upwards between November 2004 and May last, aggregating 200 basis points. So, the net rise in ICICI Bank’s floating rate till date is only 25 basis points.

In contrast, a person who had taken a fixed loan from the bank then is paying at least 25 basis points more than the floating rate even now!

Tax benefit

However, not many lenders allow floating rate borrowers to increase or decrease their equated monthly instalments (EMIs) in line with the rate revision. Instead, they extend or reduce the loan tenure. So, a borrower doesn’t actually have to pay a higher or lower EMI whenever the interest rate moves up or down.

Existing floating rate borrowers, however, can claim tax benefits on the increased EMI. Since the increase in EMI accrues to the interest component, one can claim a higher deduction under section 24.

This is beneficial for those who have already exhausted their Rs 1-lakh investment limit under section 80C. If your income isn’t taxable after taking into account the tax deduction on all investments already made, including the housing loan, extend the loan tenure.

Fixed, not really

Not many banks these days are offering a fixed rate home loan for more than 10 years. The State Bank of India and Corporation Bank offer fixed rate loans up to 10 years. Foreign banks such as ABN Amro and HSBC offer fixed rate loans for a shorter period of three years.

Those who offer longer duration fixed rate loans (more than 10 years) charge an interest rate that is at least 175 basis points above the floating rate. There’s a caveat here: even during the 10-year period, the rate may not be fixed.

“The rate may be revised by the bank every two years if the interest fluctuations are too much,” reads the footnotes on the SBI rate card. So, carefully read the fine print of your home loan documents before signing on the dotted line.

Best of both worlds

But there is still an option that offers the best of both the worlds. Banks such as HDFC Bank, ABN Amro and ICICI Bank are now offering a home loan where a portion of it can be locked into a fixed rate, while the rest attracts a floating rate.

Slice it up

Customers have the choice to decide in what proportion they wish to dice up the fixed and floating rate portions of the loan. The advantage is that it gives you the opportunity to temper the interest rate risk on a loan.

An increase in home loan rates hits prospective borrowers harder than the existing ones. A rise in interest rate increases the EMI and reduces the loan eligibility of a borrower. For example, if your take-home pay (net of all loan liabilities) is Rs 20,000 a month and your age is below 40 years, the lender bank will consider your EMI paying capacity at Rs 10,000.

Now, if you want a 10-year loan for which the prevailing rate of interest is 8 per cent, then you are eligible for a Rs 9 lakh loan. Consider now that the interest rate rises to 9 per cent. In that case you will not get more than Rs 8 lakh as loan.