Should You Go In For Hybrid (Fixed And Floating Rate) Loans?

Amidst all the hype & hoopla surrounding the home loans (teaser loans), there are customers who are still facing the dilemma to remain fixed or to float. They do not want the risk of floating especially when interest rates move upwards, at the same time they do not want high pure fixed rates. They want to avoid the risk, at least for a certain portion of the loan, and some lender’s answer to such an arrangement is known as Hybrid loans.

So what are these Hybrid loans?

It is a combination of fixed and floating, also known as partly fixed and partly floating. Under this scheme, a part of your loan is locked under ‘fixed’ and the rest is under floating – the adjustable rate of interest. In fact it is supposed to be a median option between fixed and floating interest rates. This product works best for the people who are not clear about the rate movements and do not want to take the particular stance. Depending on the risk appetite and risk perception of future rate movements, you have evaluated the pros & cons of both fixed and floating but are unable to come to any conclusion. So, as per the companies, hybrid loan is another option which can work well for customers like you.

In case of hybrid loans, there are two parts to the loan agreements, one for fixed and another for floating.

That means that if you take a loan of Rs. 20 lakh and you feel that interest rates will increase, you can choose to take 60 per cent of Rs. 20 lakh as a fixed rate home loan and the remaining as floating. The proportion can change depending on your risk appetite.

In case rate moves up, you normally have an option of foreclosing your floating component of the loan with no pre-payment penalties. In case you decide to foreclose the loan locked under the fixed portion, standard pre payment penalty will apply unless you have negotiated otherwise.

Normally the company offers an option if interest rates move up, you can get the fixed portion of your floating loan into floating. You can convert the fixed component into floating by paying a conversion fee of 0.5% – 2% or as charged by your bank of the outstanding loan amount.

In the event that interest rates rise, the portion under fixed rate will be your buffer. And if they fall, then you gain on the floating component and lose on the fixed.

This product may work well for people who take large loans because they are more interested in hedging their risks. If instead of the hybrid loan, you decide to go for the fixed interest rate loan, make sure that your loan is indeed fixed for the entire duration of the loan. But lenders mostly put in a clause in some of their loans under which they reserve the right to amend the ‘fixed’ rate in the event of an ‘extreme change in money market conditions’.

Still fixed or floating dilemma has been eased out with the introduction of Teaser loans earlier this year, where interest rates are fixed for certain tenures say three years. After that option lies with you to choose either to chose fixed or floating which is 2.5% below the PLR.

Following suit, many PSU banks have come out with offers where they are offering low attractive fixed rates for the first 3-5 years (8-8.5%) with rates reverting to the standard floating rate after that period is over. These kind of loans are popularly referred to as Teaser loans where rate in the initial years is fixed as well as low. Private players HDFC and ICICI have recently joined the bandwagon. They announced a similar teaser loan product early December, 2009. Thus presenting clearly a good option for the consumers who want to stay away from tracking home loan rates at least for a certain period of time.

So what does a teaser rate home loan mean for the Indian consumer? It means that there is a low initial interest rate that is fixed for a specified period (1 year to 5 years) and the floating rate as specified becomes applicable thereafter.

Given below is an analysis of the some of the teaser rates home loans available in the market for a 20 year home loan of Rs. 30 lacs.

Home Loan interest rates for 20 years, Loan amount of Rs.30 Lakh – as on December 23, 2009

BANK For first year Overall effective rate

SBI Easy Home Loan **** 8 8.76

CANARA BANK *** 8 9.33

HDFC** 8.25 8.63

ICICI BANK * 8.25 9

****SBI offers 8% fixed for the 1st yr, 8.5% fixed for the next 2 yrs, 4th yr onwards borrower has an option of choosing either floating rate which will be 2.75% below SBAR or fixed rate which will be 1.25% below SBAR. *** Canara Bank offers 8% fixed for 1 yr, 9% fixed for next 4 yrs, thereafter min. 10% for loans upto Rs 30 lakh.

**8.25% fixed till 31st March 2012, thereafter prevailing floating rate (currently 8.75%)

*8.25% fixed for 2 years , 3rd onwards it is FRR (currently 12.75%) minus 3.50% = 12.75% -3.50% -= 9.25%

But it is certainly not a one time decision, you need to review your decision at fixed intervals. Basically, partly fixed and partly floating interest rate loan lack interest rate transparency. The so-called fixed portion may be varied and there is no objective mechanism to ensure that floating rate floats down.

Mixed rates are normally not recommended mainly because of the non-transparency of the banks on both these (fixed & floating) rates. The risks are there even if you opt for pure fixed or pure floating, still you are not exposed to dual opaqueness.

It is advisable to use online home-loan calculators on sites like Andromeda to estimate the Estimated Monthly Installments (EMI) for the loan amount you require. You will also need to understand the difference between Fixed-rate, floating-rate, the teaser rates or the combo (hybrid) rates to determine the rate type that is best suited for you.

Hence, it is important to evaluate all the pros & cons before making a decision in favour of hybrid loans.