It is a known fact that there is no transparency in the BPLR (Benchmark Prime Lending Rate) system and banks and home finance companies (HFCs) have taken undue advantage of the same. One major grouse of existing home loan borrowers is that they are forced to pay higher rate of interest while banks and HFCs have lured new customers with much less interest rates. To overcome such anomalies the Reserve Bank of India suggested that the banks shift over to the ‘Base Rate' system with effect from July 1.
It was expected that once banks shift over to the new system, wherein more transparency would prevail, there would be no place for teaser rate loans, also known as dual rate or hybrid rate loans. In spite of displeasure openly expressed by the RBI, major home loan providers are continuing with the ‘teaser' rates.
How it works
In the Base Rate system each bank has to follow a precise formula that factors in its cost of deposits, operating costs, provision for maintaining CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) and profit margin. The actual lending rates charged will be the Base Rate plus borrower-specific charges, including product-specific operating costs, credit risk premium and tenure premium.
Teaser rate home loans offer attractive fixed interest rates for an initial period of loan repayment and thereafter, floating rates will be applicable at the interest rate prevailing then. Some banks offer fixed rate for an initial period of 1-5 years and provide an option to switch over later to floating or remain with the fixed rate. If you choose the latter, the rate will be reset after every five years.
In a scenario where interest rates are supposed to go up, opting for teaser loans looks beneficial as in the initial period of one, two or even five years, the borrower is insulated from interest hike. In the present scenario, where interest rates are bound to inch up in the near future, the teaser rate option is good news.
At the end of the initial period of reduced attractive interest, if interest rates have gone up i.e. ‘Base Rate' is increased, the borrower has to shell out higher EMIs, which may derail his personal finance planning. In the event of ‘Base Rate' going up abnormally, borrowers may not be able to pay increased EMIs regularly.
The default rates may start increasing, resulting in erosion of lender's profits. This may lead to a ‘sub-prime' kind of crisis which exploded in the U.S. in 2007, culminating in a global recession. This is the bad news about teaser rate loans.
State Bank of India (SBI), which brought in the contentious ‘teaser' rate home loan scheme in January 2009, was again the first to re-introduce the same even after the beginning of the ‘Base Rate' regime.
The largest mortgage lender, HDFC, which had criticised the teaser rate home loan announced by SBI and cautioned the entire finance system of dire consequences and likelihood of ‘sub-prime' kind of disaster in waiting, had to follow suit later, as it started losing ground to the competition. Now also, after SBI announced the continuance of teaser rate loans, HDFC has followed suit, so has the third largest home loan provider, LIC Housing Finance Ltd.
SBI charges eight per cent interest for one year from the date of first disbursement of loan and disbursed between July 1 and September 30, 2010. During the second and third year the interest charged will be nine per cent. From the fourth year onwards, the prevailing interest rate will be applicable.
HDFC charges 8.25 per cent interest for loan sanctioned before August 31, 2010 and disbursed (at least partly) before September 30, 2010. From April 2011, the interest rate charged will be 9.25 per cent up to March 31, 2012. From April 2012, prevailing rates will be applicable.
LIC Housing Finance Ltd. charges 8.9 per cent interest for new home loans from July 1, 2010 upto March 31, 2012. From April 1, 2012, the interest will be the prevailing rates then. LIC Housing has also another scheme offering 9.25 per cent interest for the first five years and thereafter floating rates prevailing will be applicable.
No level-playing field
If the rate war continues amongst leading players, it may create a kind of bubble, which may burst at any time. Since large players have cheaper funds at their disposal and there is surplus liquidity they can afford to play such gimmicks which are not in the interest of either the borrowers or the lenders.
The gimmicks also disturb the level playing field that hitherto existed amongst large, medium and small players.
The unfair trend of luring new customers with lesser interest rates and forcing the loyal, existing customers to shell out higher interest rates will never end if ‘teaser' rate loans are allowed to continue.
The basic purpose of introducing the ‘Base Rate' system will be defeated.
It is high time the regulatory authorities, RBI and NHB (National Housing Bank), intervened and guided the banks and HFCs accordingly.
(The author is a Director of Institute of Home Finance and can be contacted at firstname.lastname@example.org)