Hybrid loans the best bet when rates are high

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As interest rates for home loans are on the rise, banks are trying to make them more affordable.

One such measure is the introduction of hybrid home loans.

Though this was introduced in India in 2004, it became popular only recently when the interest rates started heading north.

So, people taking loans, were discussing about the pros and cons of fixed and floating rates, may now think about hybrid home loans, as nobody can be 100 per cent sure of what could unfold during the long-tenure of a home loan.

What is it and how is it?

As the name suggests, a hybrid home loan is a combination of both fixed as well as floating rates. It is also known as ‘partly fixed-partly floating’ home loan.

There are two types of hybrid home loans:

Part fixed and part floating: Under this scheme, a part of your loan — as per your choice — is locked under fixed rate and the rest is under the floating rate. It is therefore a ‘mixed’ option for people, who are confused about the future movement of interest rates.

Thus, one can lessen the impact of the adverse changes in the interest rate regimes and at the same time, avail the benefits that may come if favourable changes happen.

For example, if you take a home loan of Rs 10 lakh, you can choose to take 60 per cent of it — `6 lakh — under the fixed rate home loan and the remaining Rs 4 lakh under the floating. This proportion can change based on your risk appetite.

Your risk appetite would be high if you go for a higher floating component in a rate hiking scenario and vice versa.

In case if the interest rates move up, you have the option of foreclosing the floating component of the loan or switch it into fixed rate as in any other case. For some banks, foreclosure of the floating component will not be charged with any penal interests while that of the fixed portion, the standard two per cent pre-payment penalty is applicable.

Another option available is that if the interest rates go down, you can get the fixed portion of your loan converted into floating. This can be done by paying a conversion fee which comes around 0.5 per cent of the outstanding loan amount.

Teaser Loans: Many banks and housing finance companies sometime back launched special hybrid home-loan called teaser loans, which charges interest rates as low as 9-11 per cent for the first three years.

Thereafter, the loan rates will float or get fixed to a rate based on the prevailing one. The interest rate for the first three years can be either fixed or floating as per the bank’s scheme or the choice of the customer.

Lenders, by introducing this clause, build a cushion to share the burden with the borrower if changes go beyond their expected range.

In all cases, fixed rates will be slightly higher than the floating one. So if the interest rates do not rise significantly, the home buyer opting for a fixed rate anyway pays a higher rate.

Now-a-days, hybrid loans are as popular as a fixed rate or a floating rate. However, this scheme has been withdrawn by several banks as RBI felt that once the teaser period is over borrowers could struggle to repay leading to defaults.

Points to take care

Very few such schemes have purely fixed or transparent floating rates. So if you are opting for a hybrid product, make sure that the financier provides a clear amortisation of the loan payback. Knowing how the principal and the interest are carried out in this loan is very important. Be thorough of the incidental charges for fore closure or switching. This may vary from time to time and from bank to bank.

It is always recommended keep an eye on the interest rate movement and see if a loan switch is more viable. However, if you are someone who does not want to go through the entire process of paper work, you could perhaps give hybrid loans a thought.

The writer is the CEO of bankbazaar.com