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“What goes up, comes down!” – this is the universal law of gravity. Do you believe your home loan or car loan or loan against property has tended to defy this law of gravity? Do you feel that the rate only floats up and rarely, if at all, floats down? You may be right, and here’s why.
A floating rate loans will have one of the following as its benchmark
- the prime lending rate (PLR) in case of loans from NBFC’s and housing finance companies
- the base rate in case of loans from banks (starting 1st July 2010)
The principle - Interest on floating rate loans consists of two parts – a benchmark and a spread. The benchmark rate is supposed to reflect the market movement in interest rates and accordingly the applicable rate on a floating rate loan is supposed to float.
The Practice –
First, let’s talk about PLR benchmarked loans:
- The PLR is set by the lenders themselves and not by a third party or a market regulator. Hence, lenders are prompt at increasing benchmark rates but very slow in reducing benchmark rates.
- PLR based loans are mostly priced at a discount to the PLR – what it means is that the loan that is offered at say, 10.25%, is priced as PLR of, say 16% and a negative spread of 5.75%, taking the net to 10.25%. When market interest rates go up, lender increases the PLR and the applicable rate for all existing loans goes up. However, when interest rates trend downwards, the lender may not change the benchmark (PLR) but may simply increase the negative spread for new customers, thereby benefitting new borrowers and still charging higher rates to the old borrowers.
- Lets explain this with an illustration. Say, a lender gave a home loan at 10.25% six months back, pricing it at PLR of 16% and a negative spread of 5.75%. Now, in case the interest rates in the market move up by 0.50%, the lender will increase the PLR to, say 16.50%, thereby increasing the applicable rate on the home loan to 10.75% (calculated as 16.50% less 5.75%). However, in case the interest rates in the market were to trend downwards by 0.50%, the lender may keep the PLR unchanged. Thereby, the existing loan holders will continue to pay the old interest of 10.25%. In order to compete in the market and acquire new customers, the lender will offer new loans at 9.75% priced as PLR of 16% and negative spread of 6.25% instead of 5.75% earlier.
- This is why it has been observed that the PLR of banks and other lenders tend to be rather sticky. In fact, it is noteworthy that some HFC’s that used to offer home loans at PLR minus 2.50% five years ago, today offer home loan at PLR minus 6.50%! There is no justification as to why the bank or the lender is offering a lower rate to a new customer and not to the existing customer. Despite repeated nudging by the RBI to stop banks from discriminating between old borrowers and new borrowers, this practice by NBFC’s and HFC’s continues unabated till date.
- In order to prevent the customer from changing to another lender at lower rates, the lenders imposed prepayment charges even on floating rate loans. Thankfully, the RBI and NHB have banned prepayment and foreclosure charges on floating rate home loans. This move has made it possible for people to avail home loan balance transfer without paying penalty and thus save interest cost. However, other floating rate loans like car loans, loan against property, etc. continue to suffer from the same problem.
Now, lets talk about the base rate benchmarked loans
- The base rate system was introduced by the RBI from 1st July 2010. Just like the PLR, base rate is also a benchmark rate but with one key difference – base rate is the minimum rate below which no bank can offer any loan. We will explain you the importance of this one difference and how it helps you save money.
- Let’s go back to our earlier example of a home loan availed at 10.25%, this time under the base rate system. As we said, banks cannot lend below the base rate. So, if the applicable rate on your home loan is 10.25%, the bank’s base rate at this time must be less than 10.25%. Say, the base rate of this bank at the time of disbursing this home loan was 10.0%. So, the loan was priced as base rate of 10% and spread of 0.25%. When market interest rates go up, bank increases the base rate and the applicable rate for all existing loans goes up. When interest rates trend downwards, the bank has no choice but to reduce the base rate as it is not allowed to lend below the base rate. Thus, any benefit of lower rates will have to be passed to both old borrowers and new borrowers.
- Lets again look at our earlier illustration. Say, the bank gave a home loan at 10.25% six months back, pricing it at base rate of 10% and a spread of 0.25%. Now, in case the interest rates in the market move up by 0.50%, the bank will increase the base rate to, say 10.50%, thereby increasing the applicable rate on the home loan to 10.75% (calculated as 10.50% plus 0.25%). However, in case the interest rates in the market were to trend downwards by 0.50%, the bank will have to price its new home loans at 9.75% to be competitive in the market. However, the bank can do so only if it reduces its base rate to at least 9.75%. Most likely, the bank will have to reduce its base rate by 0.50% and pass the benefit to both old and new borrowers.
- So, the base rate benchmarked loans provide a better and more transparent interest rate transmission for the borrower. But there is a catch!
- Some banks (a handful of them) have taken a view that not only the base rate but even the spread over the base rate in case of a floating rate loan can be kept variable. One wonders how one would call this a “benchmarked” loan. This practice of a few banks has caught the attention of the RBI and the latest recommendations have suggested banning this practice.
- The base rate regime is applicable only to banks and not to NBFC’s and HFC’s.
So, when you take a floating rate loan, please check the following five things:
- What is the benchmark rate – PLR or base rate?
- What is the spread – positive or negative?
- Is the spread fixed for the loan tenure or is it variable?
- What is the track record of this lender/ bank’s benchmark rate – how often has it changed
- What will be the loan tenure – not just at the interest rate but also if the rate goes up or down by upto 1%
The main recommendations that myloancare believes will benefit the home loan and car loan retail borrowers are:
1. Transparency in setting the benchmark rate or base rate, suggestion for IBA set base rate – banks set their own base rate subject to the condition that they cannot lend to any customer below the base rate.
Tracking the movement of individual banks’ base rates since July 2010, myloancare observes that:
- During this period, the RBI has raised its benchmark repo rate by 250 bps
- Among large public sector banks, SBI’s base rate has increased by the same 250 bps, those of PNB and IDBI Bank have increased by 225 bps each and those of OBC and IOB have increased by 200 bps each
- Among private sector banks, the ICICI Bank’s base rate has increased by 250 bps (same as repo rate). However, when we look at smaller private sector banks, base rate of IndusInd bank has risen by 400 bps, that of Yes Bank by 375 bps, and those of Axis Bank and Kotak Bank by 275 bps each
- Among foreign banks, Standard Chartered Bank and Citibank have raised their respective base rates by 250 bps, while Deutsche Bank and HSBC have raised their respective base rates by 320 bps and 275 bps
It is difficult to understand how, for banks operating in the same macro environment, the base rate movements can be so different ranging from 200 bps to 400 bps over the same period of time. In this light, RBI’s suggestions of linking base rates to marginal cost of funds and about an IBA determined base rate (IBRR) are welcome moves from a home loan borrower’s standpoint.
2. Keeping the spread over base rate constant for floating rate loans. Interest on a floating rate loan is calculated as combination of two factors – a benchmark (or base rate) and a spread above it.
- Conventional wisdom and common sense suggest that while the applicable interest rate varies with the market movement, the spread remains constant. That’s why the floating rate loans have a “benchmark”.
- Some banks have taken a view that in a floating rate loan, not only can they vary the benchmark, but also the spread.
- To consider an illustration, assume a bank sanctions a home loan at 10.25% with the benchmark at the time of sanction being 9.75% and the spread being 0.50%.
- Let’s consider a scenario of rising interest rates whereby in the next reset cycle, the bank’s benchmark rate has gone up to 10.00%. Logically, the interest rate on the loan should move up to 10.00% plus 0.50%, that is 10.50%. However, what if the bank decides to also increase the spread from 0.50% to say, 1.00% and take the interest rate on home loan to 11.00%?
- Now, let’s consider the opposite scenario, one of falling interest rates whereby the bank’s benchmark drops to 9.50%. Here again, instead of reducing the applicable rate on customer’s home loan to 10.00%, what if the bank decides to increase the spread from 0.5% to say, 0.75% and keep the interest rate on home loan unchanged at 10.25%?
- Howsoever illogical this may sound to ordinary borrowers, some banks have regularly practiced this, leading to plethora of complaints with nodal officers and even the RBI Banking Ombudsman.
The RBI working group has now suggested that the spread must remain constant except in case of a change in credit quality of the customer. This proposed move is one that home loan borrowers must welcome and thank the RBI for.
3. Easing process of home loan balance transfer
With the abolition of penalty or charges on foreclosure even by way of home loan balance transfer in case of floating rate loans, more and more home loan borrowers are opting for home loan takeover to take advantage of lower rates offered by banks to new borrowers.
Some procedural issues need to be resolved to make the process easier. These relate to:
- Transfer of property documents, which tends to hold up the loan transfers.
- Procedural hurdles some banks impose in loan transfers. Some banks insist on a minimum notice period, of say, 15 days, to process a balance transfer request. Further, they tend to drag their feet on providing requisite documents like list of documents and foreclosure letter. Some banks hold up the request citing ‘internal process ad approval” – though the fact is that the customer is only exercising his right and hence needs no approval.
Creation of a central third party and independent depository of property documents will go a long way in ensuring smoother and quicker transfer of home loans. Further, a mandatory directive to process home loan balance transfer across the counter is called for.
Now, it would be great if the RBI Working Group recommendations are also made applicable to the home finance companies that are governed by the National Housing Bank (NHB). It is noteworthy that the NHB had taken the lead on abolishing prepayment penalty on floating rate home loans. So, who knows, if the NHB may soon also bring in similar regulations soon.
With fingers crossed, myloancare joins home loan borrowers in wishing that the recommendations of the RBI Working Group are accepted and implemented at the earliest.
- You can avail a loan for buying your home not only before buying one but typically also within six months of buying it as a refinance at same interest rates
- In case you rent out a house bought with borrowed money, you can claim the entire interest paid on the borrowed capital as deduction from rent earned. If interest exceeds rent in a year, the loss can be set off against salary or business income in the same year
- There are loans available in the market that offer an overdraft facility at a small cost with home loans. This helps reduce interest on home loan by parking temporary surplus into these linked home credit accounts
- You can improve your home loan eligibility by adding your earning immediate family members as co-applicants. These include spouse, brother, sister, parents, children (21+)
- Floating rate home loans can be prepaid partly or fully at any time without any prepayment penalty. Fixed rate loans typically carry prepayment penalty close to 2%
Transfer of home loan from one lender to another has picked up significantly as borrowers find they can reduce their interest outgo by upto 10% by doing so. We highlight the important precautions borrowers must take to manage the balance transfer process smoothly so as not to face any problem.
Check interest rate track record of the new lender
You must check that the lower interest rate being advertised by the new lender is real and not a shot term gimmick. Please ask your loan advisor for the benchmark rate track record of the new lender.
Satisfy yourself about service quality of the new lender
Check that the service quality offered by the new bank you are choosing is up to your expectations. Lower rate should not come at the cost of inferior service.
Check the benchmark rate
There are two commonly used benchmark rates for home loans – base rate and prime lending rate. Base rate benchmarked loans are known to be more transparent and hence preferable over prime lending rate benchmarked loans.
Is the spread variable or fixed
Interest rate on floating rate loans consists of two parts – benchmark rate and spread above it. While the benchmark rate is expected to change over time, the spread is supposed to remain constant except in case of a default. However, some banks offer floating rate loan with both the benchmark and the spread being variable. In case of many such loans, borrowers see their loan interest rates rise sharply after a few months. So, avoid loans with variable spreads and instead opt for floating rate loans that vary interest rate only with change in the benchmark rate.
Estimate transaction cost
Check the cost that you will incur for effecting the change. These include processing fees, stamp duty (in some states like Maharashtra) and documentation charges.
Issue notice to existing bank
Some banks insist on a prior notice before you can prepay your home loan. Check your loan agreement carefully and ensure that due notice is given to or waived by your existing bank.
In case the property whose loan you are transferring is still under construction by the builder, some additional points must be taken care of:
Check loan eligibility as per new bank
Cost of property consists of multiple heads such as basic price, preferred location charge (PLC), external development charges, internal development charges, security deposit, electrification charges, power back-up charges, service tax, fire fighting charges etc. Norms for inclusion of each cost head differ across lenders. In case your chosen new bank does not include some of the heads in the cost of property which were included by the old bank, the loan eligibility may come down and you may need to increase your own contribution.
Select the right time to do the loan transfer
The process of loan transfer may take 10-15 days from the date of application and your existing bank may typically take another 10-20 days to handover property documents to the new bank. You will not be able to avail further loan disbursements during this period. Hence, it is important you time the transfer of your loan at a time when you don’t expect any fresh demand from the builder for the next month or so.
Get fresh Permission to Mortgage and Tri-partite agreement
Your builder will need to issue a fresh permission to mortgage (PTM) to the new bank and enter into a new permission to mortgage. This typically takes no more than 2-5 days but borrowers must check with the builder.
In summary, balance transfer is beneficial to borrowers as it helps reduce cost of borrowing significantly. Home buyers and home loan borrowers must exercise caution in the process of balance transfer so that the process is smooth.
Business entities can now access their credit report directly from CIBIL to see where the company stands in the financial life cycle and identify critical areas that need improvement to further enhance its credit worthiness and improve the eligibility for financing.
Don’t be a pappu! Compare options, select the best one and then apply. Read the legend of Mr. B at http://www.myloancare.in/about-us. Be sure to check all terms and the fine print before you decide on a loan. Be sure the low interest rate you see is real and not a gimmick. Join Rajat, Sumit, Daanish, Anna, Nitin, Sanjeev and many others who availed loans through myloancare and experience our pres sales and post sales service. Welcome to myloancare’s online loan factory!
HDFC reduced rates by 25 bps for home loans availed before January 31, 2013. The interest rate charged is 10.25 per cent for loans up to Rs 75 lakh. “HDFC has announced a special winter bonanza for its home loan customers effective Friday, December 20. This is a limited period offer and is valid for all new applications submitted before January 31, 2014 and first disbursement taken by February 28, 2014,” HDFC said in a statement earlier this week.
In RBI’s credit policy review on January 28, 2014, the repo rate, at which banks borrow short-term money from RBI, was raised by 25 basis points, or 0.25 percentage point, to 8 per cent. The reverse repo, at which RBI borrows from banks, was raised 25 basis points to 7 per cent. The marginal standing facility, the penal rate of interest for banks, was raised 25 basis points to 9 per cent to maintain the corridor. The cash reserve ratio was unchanged at 4 per cent.
RBI keeps repo rate unchanged at 8%, CRR unchanged at 4%. RBI keeps MSF, bank rate unchanged at 9%. Sees FY15 GDP at 5-6%. RBI increases the liquidity provided under 7-day and 14-day term repos from 0.5 per cent of NDTL of the banking system to 0.75 per cent, and decreases the liquidity provided under overnight repos under the LAF from 0.5 per cent of bank-wise NDTL to 0.25 per cent with immediate effect. The RBI Governor commented, “At the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases undertaken during September 2013-January 2014 to work their way through the economy.”
ICICI Bank has introduced a ‘special scheme’ that will offer home loans up to Rs 75 lakh at 10.25 per cent rate. The rates for home loans above Rs 75 lakh will be at 10.50 per cent, an ICICI official said confirming the news. For existing ICICI bank customers, interest rates remain at 10.40 per cent for upto Rs 75 lakh and 10.65 per cent for loan above Rs 75 lakh. The offer will be available till January 31, 2014 with immediate effect. The base rate of ICICI Bank is at 10 per cent.
There has been a huge rise in the number of people under 30 years of age seeking credit in the last five years, according to credit information provider Cibil report. While those under 30 years constituted just around 7% of the new credit applicants in 2008 and the same has grown to over 25% now, the Cibil report said. Cibil further said it could be noted that the demographics have undergone a radical shift in the past decade, with the country getting more “younger”, i.e. the percentage of working age population (between 15 and 35) growing rapidly. Youth are driving credit growth with 60% of new loan applications coming from applicants, who are under 40, the CIBIL report said.
PNB Housing Finance is offering special schemes on home loans for their customers. They have introduced fixed interest rate schemes and consistent EMIs for 10 years. The loan is available on any sum of amount, upto Rs. 75 lakh bank is availing funds at 80% of market value and above Rs. 75 lakh funds are allocated at 75% of market value. The rate of interest applicable on loan amount for salaried and self-employed professional is 11.0% to 11.50% and for self employed non-professional is 11.25% to 11.50%. This scheme is also applicable on loan against property @ 13.5% rate of interest.
PNB Housing Finance introduces 3 year, 5 year & 10 year fixed rate scheme across all loan products w.e.f 1st Feb,2014
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