A home loan borrower is usually aware of two kinds of home loan interest rates: fixed and floating. But did you know that a fixed interest on a home loan eventually gets converted into a floating rate
That’s why reading the home loan reset clause is so imperative.
What is a home loan reset clause?
A home loan interest rate reset clause allows the lender to review the interest rate and reset it after a certain number of years, so that it is in line with the prevailing interest rate. This clause allows lenders to increase interest rates according to the increase in market rates.
Why is this clause included in the home loan agreement?
There are two types of interest rates on Home Loans i.e. fixed rates and floating rates. Earlier, borrowers opted for fixed-rate loans instead of floating-rate loans, even though the interest rates on fixed loans were higher than the latter. This was because fixed interest rates did not change during the tenor of the loan. To compensate for the additional risk of increasing market rates, lenders charged a slightly higher interest rate on fixed loans in comparison to floating loans.
But, when interest rates were rising at a high rate continuously, lenders had no option but to include a reset clause on a fixed interest loan. This allowed for the interest rate to be corrected as per market conditions after a few years had passed. The reset clause makes fixed-rate home loans equivalent to floating rate loans after a certain period.
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How does it work?
The clause allows the lender to correct the interest rate on long-term loans, after a specified tenor has lapsed. It ensures that the loans are being extended at a rate of interest that is in keeping with market trends. It enables lenders to increase interest rates on existing loans to reflect market rates.
Home Loans with a reset clause are generally mixed-rate home loans, wherein the interest rates remain fixed until the specified tenor (usually 2 to 4 years). After the expiry of this tenor, the loan gets converted into a floating rate loan.
The fixed-rate that is charged initially is usually 10 to 20 bps higher than the prevailing floating interest rates. There are various factors like the money market conditions, prime-lending rates, etc. that affects the interest rate in the years to come. Thus, if you are planning to take a home loan that has a reset clause, you should familiarise yourself with the possible changes in your monthly outflow.
Additional Read: Your Guide to Getting Better Home Loan Interest Rate
Other conditions of the reset clause
There may be certain conditions linked to this clause, for e.g., the hike in interest rates may apply to borrowers taking a loan above certain amount or beyond a certain tenor. Even the period for the review and hike in the interest rate is mentioned in the loan agreement. So, as always, it is advisable to read it carefully.
Thus, you should carefully go through your home loan agreement and understand the reset clause. Make sure you compare fixed and floating interest rates so that you can make an informed decision.
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