The RBI wants to rein in inflation and may shut the door on teaser loans
In the past one-and-a-half years, major banks and Home Finance Companies (HFCs) have been luring home loan aspirants with dual rate loans or hybrid loans, aptly known as ‘teaser loans.'
Under dual rate schemes, banks/HFCs would charge highly attractive interest rates for an initial repayment period, say one to three years, and later on, as per prevailing rates.
Teaser loans look attractive and may lure customers to seek higher amounts, as in the initial period, EMIs would be calculated at 1.5-2 per cent less than the prevailing rates. But if interest rates go up after the initial period (first one to three years where interest rate charged is much less than market rates and fixed also), higher EMIs may become a burden to the borrowers.
Such situations may force borrowers to default on repayments. Large scale defaults may even lead to a ‘sub-prime' kind of crisis.
Teaser loans are also found to be unethical in the sense, the existing loyal borrowers were coerced to pay higher rate on interest, while new customers were lured by much lesser interest rates. Even after publicly criticising the concept of teaser loans and cautioning the aftermath effects, HDFC, the largest home loan lender, also followed in the footsteps of State Bank of India, the largest bank, which pioneered teaser loans. Thus teaser loans became the order of the day, as almost all home loan lenders started offering teaser , which is continuing even now.
How it affects the common man
Let us analyse an illustration of a typical teaser loan.
Mr. Anand Rao has availed Rs. 20 lakh home loan for 20 years' tenure to buy a property worth Rs. 25 lakh.
His income is Rs. 35,000 p.m. A bank has offered him eight per cent fixed interest in the first year, and nine per cent for second and third years. From the fourth year, the interest rate applicable would be the rate prevailing at that time.
The EMI for the first year is Rs. 16,729, and for second and third years, it is fixed as Rs. 17,951. After three years, the loan outstanding would be Rs. 1,872,138. Although nobody can predict the prevailing interest rates three years from now, looking at the high inflationary trends, the interest rates may rise to 12-13 per cent. If interest rate prevailing is 12 per cent in the fourth year, the EMI works out to Rs. 21,553, a jump of Rs. 4,824 p.m. (28.8 per cent) from the first year EMIs.
And if prevailing rate has gone up to 13 per cent, then EMI would be Rs. 22,815, a jump of Rs. 6,086 (over 36 per cent) from the first year EMIs.
While Mr. Rao's income might go up by 15 per cent in the fourth year and if EMIs go up by 28-36 per cent, certainly EMIs would become a burden, forcing him to default on repayments, leading to hardships .
There is every possibility of thousands of such borrowers defaulting, putting a lot of pressure on the finance system and leading to a ‘sub-prime' kind of crisis, which the U.S. witnessed recently.
Avoiding this situation
In its second quarter review of the monetary policy, announced on November 2, 2010, the Reserve Bank of India has increased key ratios to rein in the inflation and taken welcome steps to curb the teaser loan trend.
The Reserve Bank has raised the repurchase rate, the rate at which it lends to banks, by 25 basis points to 6.25 per cent and the reverse repurchase rate by a similar margin to 5.25 per cent.
Apart from raising key rates, the notable factor is that RBI has increased the standard asset provisioning by commercial banks for teaser home loans from 0.4 per cent to 2 per cent. It has also put a ceiling on the loan amount to be restricted to 80 per cent of value of property (loan-to-value ratio of 80 per cent) and increased the risk weight on high quantum loans (Rs. 75 lakh and above) to 125 per cent.
If banks decide to continue to offer teaser loans, they will have to increase the provisioning from 0.4 to 2 per cent of such loans, which will block 1.6 per cent of their huge portfolio.
Thus it is most unlikely that banks will continue to offer teaser loans any more. Exhortation ignored
Even after the Reserve Bank of India's exhort to refrain from attracting gullible home loan aspirants to teaser loans, all banks and HFCs have continued to offer such loans, giving explanations to suit their own needs.
Finally, the RBI had to intervene to contain the ensuing danger of a ‘real estate bubble burst' which would be created by the teaser rate loans. It certainly is a strategic move, and a timely one at that, to slowly freeze teaser loans and a farsighted approach.
This would also be in tune with our property finance mould.
* Teaser rate home loans look attractive in the beginning but may prove to be a burden later.
* Increase in EMIs may lead to customers defaulting on loan repayments.
* Experts fear this may lead to a ‘sub-prime' kind of crisis seen recently in the U.S. housing loan segment.
(The author is Director of Institute of Home Finance, and can be contacted at firstname.lastname@example.org )