How Money Market Clause In Home Loan Impacts Borrowers
All builder-buyer agreements invariably have a force majeure clause that provides developers leave from paying any penalty to homebuyers over project delays in case construction work is interrupted owing to unforeseen circumstances, or because of an “Act or God”. An equivalent of the same clause in home loan agreements is the money-market clause that serves a similar purpose for banks if external factors force them to make changes in interest rate, among other things. This makes it incumbent upon a homebuyer, who is planning to buy a property through home loan to get a clear understanding of the term, force majeure, and how it works in the context of home loans.
Decoding force majeure in the context of home loans
Force majeure, according to the Oxford Dictionary, is "unexpected circumstances, such as war, that can be used as an excuse when they prevent somebody from doing something that is written in a contract". All natural calamities, for example, are considered Acts of God, and the builders cannot be held responsible for project delays caused by natural calamities such as fire, earthquake, floods, storm, tsunami, hurricane, cyclone, etc.
On similar lines, banks would be excused for not meeting the commitments made under the home loan contract if they were to deviate owing to external conditions. Invariably, the force majeure clause is cited to make changes in interest rates due to unexpected conditions. The use of force majeure in home agreements is done through the money market clause.
Application of money market clause: The money market clause in a loan document states that the bank will have the right to change the rate at the time if the prevailing market conditions force it to do so, even if the loan has been taken at a fixed rate of interest. In cases where the home is provided on a floating rate of interest anyhow, the same clause provides the lenders the freedom to make changes with regard to loan tenure, et cetera.
“The term (tenure) is subject to variation as a consequence to a change in the money market condition resulting in a change in the MPLR and thus a change in the repayment terms, more specifically described in the loan agreement. The bank in such a situation as mentioned shall have the right to review the term in such manner and to such extent as it may deem fit. You shall, however, continue to pay the EMI as indicated in the loan agreement without any intimation from the bank,” reads a loan document from a private lender where the borrower has taken the loan on a floating rate of interest.
“However, if the EMI would lead to a negative amortisation (that is if the EMI is not being able to cover the interest in full), the bank shall increase the quantum of the EMI and you shall then be required to pay the increased EMI as indicated by the bank, more specifically described in the loan agreement,” it reads further.
How is going for a fixed interest rate of any help, then?
Those borrowers who decide to go for a fixed rate do it with a sole purpose getting a sense of certainty - there is a pre-determined rate at which they would be servicing the loan, irrespective of the market conditions. They sure have to pay a price to attain their surety in a market that is highly volatile and undergoes major changes at the slightest provocations.
Those who go for a floating interest rate get a loan at cheaper rates. The rate of interest on the two types might be in the range of two to three percentage points.
Currently, private lender ICICI Bank, for instance, offers floating home loans between 9-9.20 per cent. The fixed rate of interest at the bank, on the other hand, is 9.4-10.05 per cent. The country’s biggest private lender HDFC offers home loan at a fixed rate at 9.95-10.80 per cent — the banks re-sets the home every two years. In comparison, floating rates loans at HDFC cost you 8.85-9.05 per cent. At Axis Bank, a borrower will have to pay 11.75 per cent interest to get a fixed rate loan for a 20-year period. The floating rate of interest at the bank is 9.2 per cent.
Also, borrowers have to pay pre-payment charges if they at some point during the loan tenure decide to pre-pay it. This is not true of home loans with an adjustable rate.
Rates would remain fixed only for a certain period unless a borrower gets the bank to categorically mention in the agreement that the rate would remain fixed for the entire period.
“Apart from a regular fixed rate product where the rate of interest is constant over the entire term of the loan, there are variants available which allow you to fix your interest rate for specific periods of 2, 3 or 10 years, and is available with the right of reset by the lender at any point in time,” reads a blog post at private lender HDFC’s website.
“Depending on what is mentioned in your home loan agreement, the bank would keep the rate unchanged for some years during the loan repayment tenure. In some cases, it could be three years, in others it could be seven,” says Nitin Kumar Khandelwal, who works at the home loan division of PropTiger.com.
Also note here that some banks do not offer fixed rate home loans.
“The bank resets the rate which is linked to the marginal cost of funds based lending rate after a period of one year. So, for that period, it remains fixed anyhow. Due to that, it has stopped to grant loans based on the fixed rate of interest rates,” says an official working with SBI on the condition of anonymity.
Despite the higher cost, experts still believe that a borrower should certainly choose a fixed rate home loan when rates are low.
“Home loan rates were at record low recently when most banks were offering as low as 8.30 per cent. From there, rates were only expected to increase. At a time like that, it is quite prudent to go for a fixed rate based home loans,” says Khandelwal.