Basis of home loan interest rates charged by housing finance companies
Housing finance companies (HFCs) are regulated by the National Housing Bank Limited (NHB), a subsidiary of the RBI. The funding of housing finance companies, is different from those of banks. So, the basis of charging interest on home loans granted by housing finance companies, is also different from the one adopted by banks. These companies base their actual lending rates against a benchmark rate, which is called Benchmark Prime Lending Rate (BPLR). Interest rates for all the loans are calculated with reference to this rate. This is generally the highest rate that the housing finance company charges. So, a majority of the home loans, are given at a rate that is below this PLR.
Drawbacks of the PLR regime
As no borrower can know the bottom rate, at which the HFC grants home loans to their best customers, this basis of charging interest is not transparent, as you never know whether you have got the best rate. Moreover, these lenders do not change their PLR as frequently as the banks change their rates. In order to entice and get new customers, housing finance companies may give more discounts on their PLR. This may seem unfair to existing customers, who remain locked at interest rates with lower discount to the PLR. The existing borrower will get the benefit of lower rates, only when the lender reduces its PLR, which does not happen so frequently.
Should borrowers opt for a housing finance company or a bank?
Hence, if you have a good credit rating, it is advisable to take the home loan from a bank, rather than a housing finance company. In case you want to avail the rate which is offered to the new customers, you are required to pay a switching fee. Why then, do people go to housing finance companies? In a majority of the cases, the borrowers have some problem, either with the documents of the property or their income proof or a bad credit rating. As this carries higher risks for the lender, a higher rate of interest is justified.
Basis of home loan interest rates of banks
Earlier, banks also used to give home loans on the basis of the PLR. From July 2010, the RBI introduced the concept of a ‘base rate’, for computing the lending rates – a rate below which the banks were not allowed to lend even to the best of the borrowers. The purpose of introducing the base rate, was to bring transparency in the transactions and to ensure that the banks pass on the reduction in repo rate to the customers, quicker than what was happening under the PLR regime. The first purpose was served, as the base rate served as the bottom rate. Consequently, borrowers knew exactly what premium they were paying, over the best of the customers who could get the home loan at the base rate.
Drawbacks of the base rate regime
However, the banks were not so quick, in passing on the benefits of reduced repo rates (the rate at which the banks borrow from the RBI). Moreover, banks devised ways to calculate their base rates differently. The base rate was supposed to be based on the cost of funds for the banks. However, as the banks had a portfolio of old deposits and borrowings carrying higher rates, this resulted in very marginal reduction in the base rates every time the RBI reduced its repo rate. This is evident from the fact that while the RBI reduced the repo rate by 175 basis points between January 2014 and October 2016, the banks reduced the base rate by only 50-75 basis points, thus, denying the consumers the benefits of reduction in the repo rate.
What is the MCLR regime?
To ensure that the banks pass on the benefits of reduced repo rates and cost of borrowings to the consumers quicker, the RBI made it mandatory for all banks to link all the loans to the marginal cost of their borrowing for different tenures.
The banks are supposed to work out the marginal cost of fund-based lending rates for different tenures, like overnight, one month, three months, six months and 12 months, unlike the base rate, which was used for lending by the banks for different tenures, without looking at the corresponding borrowing based on tenure.
The existing home loans taken under the PLR or base rate regimes, shall continue to be governed by the respective regime, till the loans are fully repaid, unless the same have been switched to MCLR. Also, the home loan rates will not change with each change in the MCLR, as the banks are allowed to have a reset period (maximum of one year), either linked with the date of disbursement or a pre-determined date, when the home loan interests will be aligned with the existing MCLR.
(The author is a taxation and home finance expert, with 35 years’ experience)