Banks introduce reset clause to home loan

Over the past few months number of factors has been responsible for the hike in home loan interest rates. The Reserve Bank of India (RBI) has increased the repo rates and reverse repo rates which has added to the interest rate increase process. Hence interest rates on housing loans are no exception.

Till now, it was believed loans carrying a fixed rate of interest did not get affected with interest rate movements. They were supposed to remain neutral to the market movements. But with the recent continuous increases in the interest rates, this has led to loss for banks. Therefore many banks have searched a way out by introducing a reset clause in their fixed home loan documents to effect a change in the interest rate at a future date.

The reset clause will allow banks to review rates at the end of certain time period. Some banks have set the reset clause as applicable at the end of certain number of years - usually two to three.

Most banks have started introducing these clauses in their home loan documents since the interest rates started moving upwards. With this reset clause the fixed rate loans become equivalent to floating rate ones and nothing remains fixed in the strict sense of the word.

From the viewpoint of banks and financial institutions, such a step may be necessary as they no longer have access to relatively cheap long-term lines of credit to offer long tenure fixed rate loans. In case of most of the banks, the average tenure of deposits is less than four years, and if they lend for a longer period, their cost of funds strike high as also the yields. Over the past the interest rates have become unstable.

Following the increasing instability in the interest rates, the banks are not ready to take a view on where interest rates are headed in the times to come, as banks are already under pressure to protect their margins. Because of all these factors banks are forced to review the pricing and product structure of loans.

With reset clauses Bank would be able to revise the interest rates on loans in case of certain circumstances. The banks will have the discretion to increase the interest rates in case the market rates of interest increase. This tends to evade the banks against interest rate increases at a future point in time. But this is going to put the borrower in a disadvantageous position. In any case the fixed rate of interest is higher than the floating rate.

The criteria that can trigger the rest clause have been specified in the loan document. Reset clause depicts changes in interest rates to the fixed rate borrowers. The only difference in respect of a floating rate loan is that changes in the interest rate don't happen frequently.