Fixed V/s. Floating Interest Rates

Fixed Interest Rate Home loans
Now, let us presume Mr. ABC was in the process of buying a house. He was undecided to choose between a fluctuating rate option (in which the interest rates increase or decrease depending on the movement of a base rate) and a fixed rate option in which the rate remains constant over the period of the loan. The variable rate option was quarter percentage point cheaper to start with than the fixed rate option. However as the interest rates were widely expected to move up he decided to go for a fixed rate loan even though the variable rate loan was cheaper to start with. He signed the fixed rate loan. As expected the interest rates went up and Mr. ABC was happy that he had managed to save a pretty packet by following his instinct and locking himself with the fixed rate loan.
However his jubilation was shortlived. His documents had been submitted and he was awaiting disbursement. Such a case the new increased rates would apply on his loan. He had just discovered the dichotomy of the fixed rate loan , i.e they become fixed only on the date of disbursement. In this case Mr. ABC had to pay the new increased rate on his loan even though he had the foresight to anticipate the increase in rates. To be fair to the housing finance institution if the rate had decreased as on the date of disbursement it would have applied the decreased rate for the loan. This incident highlights the ignorance of the normal customer about the mechanics of the fixed rate home loan.
World over the customer has a choice of avoiding this risk by getting into what is called a rate lock arrangement. For a small premium the housing finance company locks the rate available to the customer for a predetermined period, usually not exceeding 90 days. The mechanism normally provides for passing on the benefit of the rate reductions during the interim period between sanction and disbursement while providing for protection from any increase during this period. This enables a customer to plan his house purchase without worrying about interest rate movements.
It have been seen significant interest rate volatility in recent times. All of last year till about October 2006 the rates were falling under the twin pressures of general softening of interest rates in the economy and the intense competition among the home financing institutions.
However the rates have gone up in recent times in line with the general hardening of rates in the economy. Thus the need for a instrument like rate lock is being avidly felt.





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