As a part of the government’s initiative to bring down the interest rate of loans to a single digit, the central bank recently issued a formal notice instructing all the banks to fix a maximum 9.0% interest rate on all loans except for credit cards, effective from the 1st of April 2020.
If controlled properly, this limited interest rate can have a multifarious outcome that can positively affect the economy. This lower interest rate also translates good things for real estate investors as it can have a profound impact on the housing industry in Bangladesh. That said, how exactly can the new interest rate affect the real estate industry in Bangladesh?
Effects on the cost of capital and inflation
Interest rates can play a vital role in determining the cost of mortgage capital, which affects your decision every time you decide to purchase a property. Mortgage debt is more expensive when interest rates go up. Conversely, you’ll pay less when interest rates go down. In this case, as the banks are no longer able to increase the interest rate from 9%, the overall cost of the mortgage is expected to decrease significantly from existing costs. Before the new law, banks could set the interest rate to their liking which could go up to 14% in some cases.
Besides, interest rates are linked to inflation. As interest rates go up, capitalization rates (also called cap rates) increase. A cap rate is the rate of return that’s expected to be generated on a real estate investment. Meaning, a decrease in interest rate can actually reduce property value. From a home buyer’s perspective, this is exactly the thing that everyone would take advantage of.
An expected increase in borrowers
This new policy regarding a single-digit fixed interest rate can influence a lot of prospective borrowers to actually go for the home loan that they were not sure about because of the high-interest rate. When you are planning to buy, construct or renovate a property, you need a huge amount of investment. The most popular and efficient way to get that investment is to take a home loan.
Paying back loans in installments is easier than having to spend that amount in one go. And now with only a 9% interest rate, people who were reluctant to take loans before will most likely be interested in borrowing money from the bank. This also translates into a boom in the real estate sector as a lot more people will be investing in real estate.
Effects on existing and new borrowers
When it comes to home loans, there are typically two types of home loans in Bangladesh, depending on the interest type. One is called the fixed-rate loan and the other is called variable rate loans (or floating point loans). Borrowers who prefer predictable payments generally prefer fixed-rate loans, which won’t change in cost for the entirety of the borrowing period. On the other hand, borrowers who believe interest rates will decline, tend to choose variable rate loans. In general, variable rate loans have lower interest rates and can be used for affordable short term financing.
Now with the imposition of the new policy, existing borrowers who took loans under the variable interest rate scheme can enjoy this single-digit interest rate until the next revision. However, people who were under the scheme of a fixed interest rate loan won’t be able to avail this advantage as they already agreed upon a fixed interest. This is not the case for new borrowers though. People who are planning to take home loans can enjoy this 9% interest rate from the 1st of April.
Banks may set new rules for borrowers who want to take home loans with the new interest rate. The verification process can also become stricter. Additionally, the banks can also raise the ceiling for the minimum amount of loan as the cost of the mortgage will be lower than before.
A change in interest rate can affect a lot of things and their effect on real estate is simple and clear. As interest rates decrease, the value of any future cash flow increases, which in turn also increases the value of the asset (real estate property).
What do you think about the new policy regarding home loan interest rates? Will it prove to be a good thing for the real estate industry? Let us know your thoughts in the comments section below.