Home loan customers need to be very cautious in the wake of banks reviving the same, says R.P. Deshpande

After a brief interval, it seems teaser loans are making a re-entry into the home loan market, which may not be a good trend.

Teaser loans are offered as adjustable-rate loans, in which the borrower pays low initial interest, which increases after a few years. They try to entice borrowers by offering an artificially low rate and small EMIs (Equated Monthly Instalments) for initial 2-3 years; for the balance tenure, prevailing interest rates at that time would be applicable.

When the SBI, the largest bank, announced the introduction of teaser loans in early 2009, it was argued that they are good for borrowers who would get higher loan amount with lower EMIs in the initial period of repayment. It was also argued that when borrowers start paying higher EMIs, their income would have gone up, offsetting the increased repayment liability. Such loans may be good during times of stable interest rates, but increase in EMIs at current level, coupled with increase in interest rates due to inflation, will double the risk for the borrower, leading to large scale defaults.

Borrowers would be in trouble when the initial period of discounted interest rate ends and EMIs increase heavily.

The borrowers who opted for such loans in early 2009 will soon complete their honeymoon period of discounted interest rate and move to the floating rate scheme. Since they were paying EMIs at 8-8.5 per cent and interest rates have climbed to 11.5-12 per cent and may even rise to 13 per cent soon, the EMIs may increase by 30-40 per cent, as against a salary increase of 10-15 per cent, thus straining the personal finances of borrowers, forcing them to default.

Advice ignored

Looking at the fact that recently such ‘teaser loans' were instrumental in the unfolding of the ‘sub-prime' crisis in the U.S., which paralysed not only the U.S. economy but the entire global economy, Reserve Bank of India cautioned the lenders against offering such schemes. But the largest bank countered the advice and went on advocating that “the special scheme is a desirable product for consumers and profitable for our bank.”

In the fear that they would lose the market share, other leading home loan lenders, who had vehemently opposed the concept of teaser loans, joined the bandwagon and started offering similar loans. Thus, teaser loans became the order of the day. In order to curb such loans, the RBI had to intervene and make a higher provision for teaser loans, from 0.4 per cent to 2 per cent.

ICICI Bank, the largest private sector bank, has recently announced the revival of teaser loan, also known as hybrid loan or dual interest loan, with effect from August 19, 2011.

The bank offers home loans at a fixed interest rate valid for a period of either one year or two years, after which the loan will move to floating interest rate.

Under the one-year fixed rate, 10.50 per cent interest is charged for loans below Rs. 25 lakh, 11 per cent for the Rs. 25 lakh-Rs. 75 lakh range, and 11.50 per cent for larger ones. Under the two-year fixed scheme, interest is 10.75 per cent for loans up to Rs. 25 lakh, 11.25 per cent for loans in the Rs .25 lakh-Rs. 75 lakh range, and 11.75 per cent for larger loans.

Floating rate after the fixed period (one or two years) will be linked to the ICICI Bank base rate (I-Base).

Are they good now?

When interest rates were on the rise (during 2009), teaser loan borrowers had the benefit of higher loan amount with lesser EMIs to start with. But very soon, ,they face the dark reality of shelling out higher EMIs. So, the product is not beneficial to borrowers or lenders, as lenders will have to face increased defaults and higher provisioning.

In the reversed scenario now, when interest rates have almost peaked, it is expected that interest rates may go up by 50-100 base points (0.5-1 per cent) in the near future and then may start falling. Gradually interest rates may come down to 8-9 per cent, after two years from now. In such an era, if a borrower opts for a teaser loan, which entices him with 1.5- 2 per cent less interest rate as compared to fixed rate offered by other players, most likely, the borrower would be the loser, as he has to continue to pay EMIs at higher interest rates, when interest rates would have gradually come down.

In the fiercely competitive environment, once again the leading players may declare war by offering similar ‘teaser loans'.

It is high time the regulators, both RBI and NHB, intervened and put a stop to these unhealthy practices. Before that, if the lenders can collectively decide to keep away from such bad moves, it would be highly appreciable and such a move will be beneficial for the entire financial system of the country.

(The author is Director, Institute of Home Finance, and can be contacted at deshpanderp2007@gmail.com)

Keywords: home loan

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