Reset Clause On Home Loans: Here’s What You Need To Know

A reset clause applies to both fixed-rate as well as mixed-rate home loans and allows the lender to transition to a floating rate scenario after a certain period
Home Loans
Home Loans

The reset clause applies to home loans, and as the name suggests, it has distinct implications in both the fixed rate interest as well as the mixed rate interest (also known as semi-fixed or hybrid) home loan scenarios.

In a fixed rate home loan, the reset clause denotes a point at which the interest rate is adjusted after the fixed-rate period concludes. During the fixed rate phase, the interest rate remains constant, thus providing borrowers with stability in their monthly payments.

However, once the reset clause is activated, the interest rate usually transitions to a variable rate, influenced by prevailing market conditions. This can lead to fluctuations in monthly repayments, allowing borrowers to benefit from potential decreases in interest rates, but also exposing them to the risk of rate hikes.

On the other hand, in a mixed-interest rate home loan, the reset clause signifies the shift of the fixed portion of the interest rate to a variable rate after a predetermined period. These loans combine a fixed rate for a specified duration (e.g., three or five years) followed by a variable rate component.

When the reset clause is triggered, the fixed rate portion is recalibrated according to the market benchmarks, while the variable component continues to fluctuate. This structure offers borrowers a balance between initial rate stability and later responsiveness to market changes.

Says Adhil Shetty, CEO, BankBazaar.com, a financial services website: “Most fixed rate home loans are not fixed for the entire duration of the loan, but only for the first few years. This means that the interest at which you took the loan remains the same only for a specific number of years. After this interval, the lender can reset your loan rate to reflect the existing market conditions.”

Let’s say, you took a home three years ago at a fixed rate of interest of seven per cent per annum. The reset period of the loan is three years, which means that the loan will be reset at the end of the three-year tenure. Between then and now, if the interest rates have gone up by, say, two per cent, on an average, it means that the lender can now increase your rate of interest given the existing increase in rates. The reset period is part of the loan agreement.

It is very difficult to calculate the risk on a long-term loan, which makes pricing fixed loans for 15-30 years very difficult. So, lenders usually tend to offer a fixed rate for a shorter period of three-five years and then move to a floating rate of interest.

Incidentally, the floating rate of interest applied on your existing loan after the expiry of the teaser period may not be the same as that offered to borrowers who had originally selected a floating rate of interest at the time their loan was sanctioned. Hence, it’s advisable that borrowers thoroughly review and compare the fees and rates on floating rate home loans offered by different lenders and then select one that best suits their budget.

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