Did You Ask Your Lender About Your Home Loan Reset Clause?
Planning to apply for a Home Loan to buy your dream home? Take a moment and go through the Home Loan agreement carefully as we generally miss important points thinking that signing the agreement is a mere formality. Once such detail to avoid missing is your Home Loan reset clause.
What is a Home Loan Reset Clause?
A Home Loan interest rate reset clause allows the lender to review the interest rates and reset it after the end of a certain number of years depending upon the current or prevailing interest rate. This clause allows lenders to increase interest rates if the market rates increase in the future.
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 usually 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 rate Home Loans were isolated from any interest rate changes during the tenor of the loan. This allowed lenders to charge a little higher interest rate on fixed loans in comparison to floating rates to compensate for the additional risk of increasing market rates.
Also Read: Know About Home Loan Moratorium Period
But the continuously rising interest rates due to market trends were piling up losses for lenders on existing Home Loans. Consequently, lenders started including the reset clause in the Home Loan agreement. This allowed them to make changes in the interest rates in the future. This makes fixed rate Home Loans equivalent to floating rate loans after a certain time, and it is important for every borrower to know this.
How Does It Work?
The reset clause gives the lender power to revise the interest rates on long-term loans after the elapse of a mentioned period. This clause acts as a hedge for lenders against any rise in market interest rates in the future after the loan is sanctioned. 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 tenure (usually 2 to 4 years). After the expiry of this tenure, 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 rates in future. Thus, if you are planning to take a Home Loan that has reset clause, you should prepare yourself for the increase in the interest rates in future.
Other Conditions of the Reset Clause
There may be conditions linked to this clause, for e.g., the hike in interest rates may apply to borrowers taking a loan above certain amounts or above certain tenure. Even the period for the review and hike in the interest rates will be mentioned in the loan agreement, so read it carefully.
Every borrower should thus carefully go through and understand the implication of Home Loans with a reset clause and compare it with a floating rate Home Loan before making any decision.