“Un-fixed rate loans”: The new kid on the block

By Jayant Pai | jayant@ppfas.com

Recently, I read a few media articles railing against the launch of “Semi-Fixed Rate Loans” by a couple of banks. Here the borrower is charged fixed rates for a certain period – say two or three years – and then has to pay Equated Monthly Instalments (EMI) based on a floating rate (usually linked to the bank’s Base Rate).

The basic grouse of many is that banks are exploiting consumers’ fear of rising rates and launching such products just when interest rates are about to peak. Without wishing to be seen as an apologist for these banks, my view on such products is slightly different:

  • Product manufacturers often tailor a product to meet latent demand. The incessant rate hikes of the past few months have certainly instilled uncertainty and angst in borrowers’ minds. Many potential borrowers are also desisting from fresh borrowing. In such a scenario, these products offer borrowers some visibility with respect to their EMI liability. For many fence-sitters this is a welcome development as they can at least go ahead and fund their home right away with a clear idea about how much they will pay for the next few years.
  • Today, there is a virtual consensus that the Reserve Bank of India (RBI) will begin reducing rates a few months down the line. While that may be true, there have been many instances of consensus being wrong. What if rates do not come off for the next couple of years? In that case those who opt for such loans may have the last laugh.
  • Most home loans are taken for a period of ten years or more. Hence even if rates move down subsequently, this benefit will be available to borrowers once this ‘fixed rate’ period ends. Hence the weighted average interest rate paid by them may not be very much different. It also offers a good option to borrowers who could not put off borrowing and were therefore considering fixed rate loans spanning the entire tenure.

I believe that this product is as good or as bad as sector funds being launched after the sector enjoys a good run or inverse floaters being launched after a sustained fall in interest rates. Even those products cater to a demand which is already existing rather than creating new demand. In a sense they exploit the irrationality of the investor/borrower.

At the end of the day the principle of “Caveat Emptor” applies to all financial products….

You may also like to read this blogpost by Mr. Parag Parikh: If consumers are irrational it makes sense for companies to cater to that belief rather than eradicate it.

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