A reset clause in a fixed loan means, unlike popular belief, the loan interest rate would no more remain fixed for the entire tenure. It would be subject to a revision on a regular basis either two years or more depending on the decision taken by the bank from time to time. For instance State Bank of India (SBI) has a reset on its fixed loans every two years.

This is how it works: Lets say you’ve taken a fixed rate home loan for a tenure of 15 years at a 9% interest rate. You may be under the impression that for the full 15 years you’ll have to pay up only 9% interest on your home loan regardless of any future hikes taking place. But if the bank has a reset clause saying that a reset would take place every two years you would not benefit much. You would, if the bank so decides, have to pay up a higher interest rate after the stated two years. So then are fixed rate home loans really attractive in such a case?

Suresh Menon, General Manager, Operations, HDFC, says, “Actually speaking a reset clause does not bring in any major benefit for the customer. I believe it is one sided. We had introduced such a product a year back termed as a fixed rate loan with a money market clause. But have withdrawn the same now. As of now only HDFC has a purely fixed product for the entire tenure of 20 years no strings attached”.

In the current rising interest scenario the cost of funds is going up. But it is difficult to say how long this rising trend will continue. In such a case, while banks are usually in a position to hedge against short term increases, they also need to ensure that any increase in the long term is also taken care of. A reset clause would help them smoothen any cost increase they may have to face anytime in the future. Here, the reverse also applies. If, after the 2 year lock in, interest rates start falling, ideally banks would pass on that benefit to borrowers by reducing interest rates.

Opine SBI officials, “The only benefit is that whenever there is a hike in interest rates, there will not be a immediate hike on fixed rate loans due to the two year reset clause. For instance in 2005, SBI hiked its home loan rates thrice. But this did not affect those who had taken a fixed loan. They enjoyed lower interest rates for a period of two years. But after two years there would be a revision and that would depend on the factors prevailing then. In any case a fixed loan is always costlier by 0.5 to 0.75% compared to floating rates."

Harsh Roongta, Director, Apnaloan, avers, "Such products may prove to be beneficial for a brief period only. For instance it could be beneficial for a brief period at the time when the interest rates go up on a floating rate but remain fixed on a fixed loan. Now again due to the reset clause the rate increase perhaps will not take place till a period of let's say two years.”

Experts state that many banks have a reset clause attached to their fixed rate loans but some of them do not state the same clearly to the customer. The product is missold and the customer is under the impression that the loan he has taken will carry the same interest rate for its entire tenure. So make sure you read the fine print before you take that home loan.

Author: Geeta Nair