Purchasing a home is one of the most significant investments in most people’s lives. Therefore, it is crucial to be well-informed as you begin the process. Because many individuals will require a housing loan in order to make their purchase, it is crucial to have an understanding of the home loan market. In this guide, we provide explanations and analysis of the home lending market in India.
- Average Interest Rates of Home Loans
- Factors That Influence Cost of Home Loans
Average Interest Rate of Home Loans in India
As of November 2018, the average interest rates for home loans in India hovered around 9% to 10%. This rate can vary depending on a number of factors. For example, salaried employees and women are often offered cheaper home loan rates than other borrowers. Additionally, interest rates vary depending on the type of home loan (e.g. traditional home loan, loans against property, home loan balance transfer, etc.).
The table below illustrates the average interest rates of home loans by category. Compared to these average rates, the cheapest home loans in India can help you save a significant amount in interest costs each month and over the course of your loan.
Rest Rate vs Flat Rate
It’s important to understand that most loans in India are priced with “rest” interest rates, as opposed to “flat” interest rates. In contrast, loans in other countries often charge “flat” interest rates. This distinction is important because flat rates are often more expensive than rest rates due to the way each type of interest rate is calculated.
Take, for example, a 25-year home loan of Rs. 30,00,000 with a rest interest rate of 9%. This means that the bank charges interest based on the remaining balance of the loan after each month. This means that your monthly payment will be about Rs. 25,176. This monthly payment is initially made up of mostly interest payments and a smaller fraction of principal payments, but shifts towards principal payments throughout the loan. Because the interest charged is based only on the remaining balance (instead of loan principal amount) you end up paying only Rs. 45,52,767 in total interest, compared to Rs. 67,50,000 for a loan with a flat interest rate.
|Monthly Installments||Rs. 25,176|
|Total Interest Payment||Rs. 4,552,767|
How Fixed Rates & Floating Rates Work
Home loans are usually priced with fixed or floating interest rates. Those with fixed rates tend to charge a given interest rate for set number of years (typically 1 to 10 years). After this period of time concludes, the lender will charge you a floating interest rate. These rates are referred to as floating because they fluctuate based on reference rates (such as the lender’s MCLR rate) to which they are pegged.
For example, imagine that you take out a fixed rate home loan of Rs. 30,00,000 with a tenure of 25 years. If your loan has a fixed rate of 10% for 5 years, you will make monthly payments of Rs. 27,261 for the first 5 years. At the end of the 5 years you will have paid Rs. 4,63,160 of your principal. At this point, the bank will charge a new floating rate, on your remaining balance of Rs. 25,36,840. Depending on the interest rate environment of the lending market, this interest rate could be higher, lower or the same as your initial rate.
Fixed Rate vs Floating Rates: Which Is Better?
As you begin to get serious about finding financing for the purchase of your new home, you may be interested in understanding the difference between fixed and floating rate loans. Which loan type makes the most sense for you? It depends on your personal preference and trends in the lending market.
Flat to Declining Interest Rates
For example, when market interest rates tend to be stable or declining, it is generally better to choose a floating rate home loan. This is because in this type of environment floating rates tend to be lower than fixed rates because lenders are willing to accept a lower interest rate for the opportunity to earn more higher rates once market interest rates begin to move upwards.
On the other hand, a fixed rate loan will guarantee a certain interest rate for as many as 10 years, so banks charge a premium for this type of loan when market interest rates are generally low. Therefore, floating rate loans can help borrowers pay less for their home loan in this type of environment. In the table below, we show the difference in average floating rates and fixed rates for new home loans as of November 2018.
|Loan Type||Average Rate|
Rising Interest Rate
In contrast, when market interest rates are rising, it can be more advisable to choose a fixed rate home loan. Although fixed rate loans typically charge higher interest rates than floating rate loans, they help borrowers lock in rates and save when overall interest rise significantly. For instance, consider a scenario in which you have the choice of paying a 11% fixed rate for the next 5 years or paying a floating rate of 10% for now. If central banks across the world raise their rates your floating rate may increase from the initial 10% to a rate significantly higher than the fixed rate of 11%. This could translate to owing the bank thousands of rupees more in interest each year if your floating rate becomes more expensive than the fixed rate.
Factors That Influence Cost of Home Loans
The cost of your home loan will be influenced by a number of factors. First of all, it is helpful to consider the perspective of the lenders who aim to maximise returns while minimising losses. To achieve these goals, lenders tend to charge higher interest rates for loans that they view as riskier. In the next few sections, we discuss risk and other factors to help you understand how your home loan will be priced.
The first step in understanding home loan pricing is monitoring market interest rates. The trends of the overall lending market will influence the interest rate that you are offered by banks. In India, market interest rates are influenced by the Reserve Bank of India (RBI).
For example, if RBI raises its repo rate (the cost of borrowing for banks) lenders will typically increase their own home loan rates. Conversely, when the repo rate is lowered, home loan rates tend to become cheaper. As illustrated in the chart below, actual home loan rates tend to be closely correlated with the overall trends in RBIs repo rate. For this reason, it is important to be aware of trends and news related to RBI’s rates.
Your Financial Circumstances
In addition to monetary policy, your home loan offers will be affected by your own financial circumstances. Ultimately, home lenders want some assurance that you will be able to repay their loan. Therefore, if you are employed with a relatively high salary banks will typically offer you lower interest rates. Similarly, if you have very little outstanding personal debt, lenders will have more confidence in your ability to repay their loan and may offer you a cheaper housing loan.