Hold onto the certainty of a fixed rate home loan

With accommodative monetary policy coming to an end, it makes sense to lock in interest rates that will remain static for some time

The dream of every middle-class Indian family is to own a house. This is true regardless of the city in which they reside.

When a child settles into a stable job, there is enormous parental pressure to buy a house. In most cases, the child fulfills the unfulfilled dreams of a parent.

In such cases, the requirement is more of an emotional need due to which the logical risk analysis of one’s finances is neglected at one’s great risk. Rational decision making disappears as emotion takes over decision making and the borrower becomes overburdened and falls into a debt trap. This must be avoided at all costs.

Long term impact

Financial calculations ignore the fact that these decisions have a long-term impact since mortgages run for a period of 20 to 30 years.

Most of us assume that the price of real estate only moves in one direction, and that is upwards. Nothing could be further from the truth, as real estate prices in all major urban centers of India have demonstrated over the past decade. When buying a house with a large mortgage, it must be realized that signing a mortgage contract is a lifelong contract, the implications of which will be felt for half of one’s working life.

It assumes that your salary or income will perpetually increase. In most cases, the reality is contrary to expectations. This is what the current pandemic has taught us.

If you have decided to buy a house with a mortgage, buying an apartment ready for delivery is preferable. Many middle-class families discovered to their chagrin that several builders had collected payments from the banks but had not completed the construction of the apartment within the time promised. In some cases they have not been delivered even after a decade. The law of the land is apparent; the borrower is responsible for reimbursing the financial institution, whether an asset has been fully built and delivered or is suspended in between. This means you will have to pay the equivalent monthly installments (EMI) while fighting the builder in court.

Choice of mortgage

The most important decision a borrower has to make, after deciding whether to go ahead with the loan to purchase a property, is whether to take out a fixed rate or adjustable rate mortgage.

Interest rates on mortgage loans depend on the monetary policy of the Reserve Bank of India. If the Reserve Bank is in the interest rate cut cycle, then mortgage rates can be expected to be low and lower rates can be expected in the months ahead. When the Reserve Bank gets hawkish and raises interest rates, one can be sure that bank lending rates will rise.

During the life of a mortgage, one can expect several such reversals in the monetary cycle.

Today, mortgage interest rates are at their lowest for a long time. Inflationary pressures are raging across the world, and it can be safely assumed that interest rates will rise in India over the next six months and continue to be high for at least the next two years.

Monetary policy changes

Here are the reasons why the central bank would choose to change its monetary policy:

Interest rates in developed markets around the world are expected to rise because inflation levels are high in the United States (inflation is at its highest level in 39 years there).

When the U.S. Federal Reserve decides to raise interest rates, dollars that have been invested in other markets start flowing back to the U.S.

The Reserve Bank of India will be forced to raise interest rates to keep the rate differential between the two economies at the same level.

Secondly, prices of commons in the wholesale market in India have remained high in the region of 10% over the past seven months. It is not yet reflected in the consumer price index.

Due to rising raw material costs, several companies selling fast-moving consumer goods and automakers have passed the costs on to the consumer lately.

Protect the consumer

This will force the RBI to reverse its accommodative monetary policy and raise rates.

Therefore, it makes sense for a borrower to opt for fixed interest rates.

Usually, financial institutions only offer a fixed rate for three years. It is advisable to lock yourself into currently low interest rates — for the next three years.

A word of caution is in order regarding asset price expectations. High borrowing rates act as a gravitational force on asset prices. We cannot therefore expect a significant increase in real estate prices over the next three years as long as the interest rate remains high.

(The author is a chartered accountant and financial consultant)