If you've bought a house in the last three years, chances are you took a floating interest home loan and since then have received letters from your bank hiking your interest rate every few months.
In fact, even after paying your equated monthly instalments for over two years, it may be that your loan tenure is longer than when you first took it. Confused? And, on top of all this your new neighbour, who bought his house in late 2007, pays a much lower interest rate-from the same bank, for a similar house. How can that be? Rising interest rates derail monthly budgets of most families. A study by rating agency Crisil, Mortgage Finance-A Safe Haven for Lenders, says: "The proportion of monthly income being paid out as home loan instalments has increased to more than 50 per cent currently for an average home buyer from around 42 per cent (as on 31 March 2006), despite a 20 per cent increase in monthly incomes".
The twists don't end here. From September 2007 onwards, many advertisements have been announcing lower interest home loans. But, as you will find when you read the small print, this cookie is only for new borrowers. The bone of contentionThe truth about floating rate loans is that there is no transparency in the calculation of interest rates. Also, while banks are quick to hike interest rates when their cost of funds go up, the same is not true when there is a reduction in loan costs. While the trend of offering lower rates to new customers is not a new one, it became more pronounced in the last three months of the previous calendar year. During the recent festive season (September-December 2007) almost all banks announced lower rates for home loans.
For example, Axis Bank, Bank of Baroda ,Canara Bank, HDFC and Allahabad Bank reduced their home loan rate by 50 basis points for this period, while IDBI Bank reduced it by 100 basis points. All these offers were valid till 31 December 2007. The banks are free to decide the applicable rate of interest, and have their own benchmarks that vary across players. What this means is that the retail customer doesn't know which benchmark his home loan rate is based on, how this benchmark was arrived at, when it will change or even by how much. Other than fuzzy benchmarks, another tool that banks use to telling effect is the reset clause present in the loan documents. This clause gives the bank arbitrary powers and is used without any warning, especially after the banks and housing finance companies (HFCs) have acquired new customers at lower interest rates. Behind the curtainsThe main reason behind offering lower rates to new customers is that the banks and HFCs are trying to maintain the high speed of loan offtake as was in the past few years. (see: Of High Interest). According to the Crisil study, the compounded annual growth rate in fresh loans was 33 per cent during the past three years. Banks increase the discount on their benchmark rate in order to offer sops to new borrowers.
This is the real reason why old customers keep servicing the loan at the same rate while new ones are offered lower rates. However, after a specified period, new customers are also brought at the same level of the old customers.
Experts feel that the industry will not be able to maintain the same high growth rate in fresh originations as before primarily due to high cost of residential units and, to some extent, because of the high cost of credit. Harsh Roongta, CEO, ApnaLoan.com, says, "It's wrong to have different criteria for the same set of people having same profiles. The ideal scenario is to have different benchmarks for different types of products, and not people." Taking noticeThe Banking Codes and Standards Board of India (BCSBI) also feels that as contracted rates of interest for existing customers at various points of time depend on the asset liability structure of the bank's portfolio (deposits, borrowings and capital form a bank's liabilities while all loans are its assets) there can't be multiple benchmarks and interest rates charged to customers. Rates can either be below or above the prime lending rate, or the PLR, (the benchmark rate to which interest rates of all other loans are linked) depending upon the risk assessment of the borrower or the bank's interest rate structure.
Interest rates are also affected by the repo rate (the rate at which the Reserve Bank of India [
Get Quote] (RBI) borrows from the banks), the reverse repo rate (the returns that banks earn on excess funds parked with the RBI), increase in the cash reserve ratio (the portion of depositors' balances that banks must have on hand as cash) and an increase in risk weightage.
The Monopolies and Restrictive Trade Practices Commission (MRTPC) has taken notice of banks offering lower rates to new customers while hiking them for old customers. Based on media reports and complaints it received from existing home loan customers, it is looking into how banks can arrive at two different rates even when there is only one benchmark rate for each bank. Also under the scanner is the manner in which banks arrive at the rate that is charged to the borrowers. The commission directed its investigating wing in late November to probe these issues and submit its report within 60 days. If banks are found guilty, we will recommend transparency in operations," said a senior official at MRTPC. The report is expected soon.Finance minister P. Chidambaram, too, recently said that he hoped banks would cut lending and deposit rates by 50 basis points to spur investment.What should I do? In between all these different rates, how do you take care of your loan? Foreclosure. If the effective rate of interest of your loan (after accounting for the tax break on the basis of tax slab) is less than the return on investment that you can generate -- eight per cent in case you go for PPF -- it is better to invest. The cut-off rate of home loan interest comes to 11.5 per cent: at interest rates higher than this, it makes sense to repay the loan, at lower rates.Pre-payment. Those of us who cannot prepay the whole loan immediately can consider making a lump sum part pre-payment. This will bring down the principal amount and in turn the EMI or the tenure. Depending on what your concern is-paying a higher EMI or having a longer tenure-you can ask the bank to recalculate your loan. "One should be cautious that the increase in the loan tenure does not extend the loan beyond the earning years. Usually, an average Indian is debt averse and will tend to come back earlier and make a part prepayment of the loan. So, the institution may not be required to extend the term," says Keki Mistry, vice chairman and managing director, HDFC. However, you should evaluate long-term financial commitments before taking any decision. "If you have multiple loans, such as a housing loan, vehicle loan and a personal loan, then evaluate all these loans as well and prepay the loan based on its effective cost," says Mistry. Home loans are typically longer in duration than other loans but have the advantage of associated tax benefits, which reduces the effective interest on the loan. Looking ahead, banking experts do not foresee a significant reduction of interest rates in the first half of the year, but suggest the possibility of a downward revision after that. If the MRTPC report also prohibits banks from discriminating against existing borrowers by then, there would be some reason for cheer.
