Borrowers now have the option to transition between floating and fixed interest rates. How will it affect lenders and borrowers?
For over a year, borrowers who have taken big loans with floating interest rates have felt the financial heat. You see, as repo rates have been steadily increasing, it has caused a sharp increase in the interest rates on these loans. This has left borrowers worried about their loan terms going all over the place or their monthly payments ballooning like an elephant.
But there is some good news on the horizon. The Reserve Bank of India (RBI) has come up with a solution that will offer some relief to these borrowers.
Let’s take a closer look.
What’s Happening?
As reported by the Economic Times, in the past, interest rates for loans have fluctuated by as much as six percentage points within a single loan cycle. This caused a real problem for borrowers with floating-rate loans because as interest rates rose, their loan interest rates also increased. As a result, they either had to pay higher monthly instalments (EMIs), or their loan repayment period got longer, or in some cases even both.
Let’s say you opted for a loan in April 2022 for 20 years at a 6.7% interest rate. By the time your home loan’s interest rate reached 9%, your loan term would increase from 20 years to a whopping 42 years and three months! Yes, that means you would have to make 284 more EMIs than originally planned.
To address this issue, the RBI introduced new rules to reset interest rates for EMIs in floating interest rate loans. These rules require banks and non-banking financial companies (NBFCs) to clearly explain to borrowers how changes in the benchmark interest rate (Repo rate) can affect their loan, leading to changes in the EMI amount and the loan repayment period.
The RBI introduced these rules because we haven’t seen interest rate hikes like this in many years.
How Will This Impact Borrowers and Lenders?
At first glance, you might think that if borrowers opt for fixed-rate loans, banks won’t make as much profit when interest rates go up. But here’s the twist: most banks don’t currently offer fixed-rate loans. However, if they have to give borrowers the option of choosing fixed interest rates alongside floating ones, banks would include a fair markup to protect themselves from the risks of interest rate changes.
For example, according to the Economic Times, as of August 18, 2023, ICICI Bank offers floating interest rates ranging from 9% to 10.5%. But if you choose a fixed-interest rate loan, you would have to pay somewhere between 11.2% and 11.5%. Similarly, at Axis Bank, while a floating rate loan is offered at 9% to 13.3%, a fixed interest rate loan comes at a higher rate, specifically 14%.
So, yes, fixed interest rates on loans tend to be higher than floating rates, but they come with their own advantages. They shield you from the uncertainty of rising interest rates in the future. Banks aren’t losing out on this deal unless interest rates skyrocket even further.
Now, let’s talk about borrowers. While fixed rates might seem appealing initially, it is essential to realise that higher interest costs can’t be avoided. It is only preferable for customers with a specific timeline in mind to pay off their debt, and if interest rates go up during that time, you will end up paying a lot more in interest, and your repayment period might get extended. So, choosing your loan type wisely is crucial based on your financial goals and plans.
What’s Next?
Borrowers now have a newfound advantage – the ability to transition from floating interest rates to fixed ones. This option extends to both existing and prospective borrowers. But remember, switching can be costly, including foreclosure costs and more. So, choose wisely.
That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!
*The companies mentioned are for information purposes only. This is not an investment advice.
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