Home loans: India needs to promote fixed rate loans

Home loans in India, as opposed to many other jurisdictions, are floating rate loans - any variation in interest rates over the term of the loan is passed on to the borrowers. RBI's Financial Stability Report says the percentage of floating rate home loans is 94.8%. This is a rarity in the US home loan market; while the flavour changes as interest rates increase, but the proportion of adjustable rate home loans will be less than 10% there.

Indian home lenders, over time, have been loathe to take interest rate risk on a long-term funding product. The question is: who is better positioned to take the risk of interest rate changes: a financial sector entity with loads of tools in its possession for managing interest rate risk, or a lay household who has no clue or access to such tools?

There are multiple issues with floating or adjustable rate home loans. First, let us understand that as interest rates increase, a home-owner's EMIs do not go up. Instead, the lender does a maturity extension whereby the number of months over which the same EMI will be paid will increase. There are two big pains in maturity extension. First, it is a pain which is not felt; and please appreciate that there no bigger risk in life than having a problem which is not felt. There is a pain which is not realised, and therefore, it doesn't hurt. It hurts only when you need peace in life - retirement. As an example, if a home loan was taken for 20 years at an interest rate of 9% (the borrower was a young 35 year man then, hoping to have his house free at the age of 55), and 2 years later, the interest rate went up by 1%, the maturity will increase by 50 months. Which means he will have to pay the EMIs till he is almost 60. If there is one more increase during this time, one may imagine a retired man searching for income and resources to pay a lingering loan.

From a financial policy viewpoint too, floating rate home loans have an issue, which is recognised by the RBI itself in its Financial Stability Report referred above. This is about transmission of impact of policy rates. If the RBI increases the policy rate (say, repo rate), its intent is to curtail liquidity. As interest rates increase, the mortgage lender passes the burden to its existing borrowers, which reduces the net disposable income of the borrower. Of course, the contract in income available for consumption is much more for borrowers with lower income, implying a socially unjust impact of a macro-economic measure, intended to curb inflation.

When we spoke to some well known home lenders as to why they do not offer fixed rate loan products, it was told that they actually do, but they price their fixed rate loans at the higher end of the yield curve, thereby penalising the borrower for opting for fixed rate home loan. This makes fixed rate loans non-competitive, and hence, virtually non-existent.

Home lenders, including National Housing Bank, need more sensitisation and active move towards fixed rate lending products.